Many investors are still learning about the various metrics that can be useful when analysing a stock. This article is for those who would like to learn about Return On Equity (ROE). By way of learning-by-doing, we'll look at ROE to gain a better understanding of ESAB India Limited (NSE:ESABINDIA).

Our data shows ESAB India has a return on equity of 22% for the last year. That means that for every ₹1 worth of shareholders' equity, it generated ₹0.22 in profit.

Check out our latest analysis for ESAB India

How Do You Calculate ROE?

The formula for return on equity is:

Return on Equity = Net Profit ÷ Shareholders' Equity

Or for ESAB India:

22% = ₹589m ÷ ₹2.7b (Based on the trailing twelve months to June 2019.)

It's easy to understand the 'net profit' part of that equation, but 'shareholders' equity' requires further explanation. It is all earnings retained by the company, plus any capital paid in by shareholders. You can calculate shareholders' equity by subtracting the company's total liabilities from its total assets.

What Does ROE Mean?

ROE measures a company's profitability against the profit it retains, and any outside investments. The 'return' is the yearly profit. The higher the ROE, the more profit the company is making. So, all else equal, investors should like a high ROE. That means it can be interesting to compare the ROE of different companies.

Does ESAB India Have A Good Return On Equity?

By comparing a company's ROE with its industry average, we can get a quick measure of how good it is. However, this method is only useful as a rough check, because companies do differ quite a bit within the same industry classification. As is clear from the image below, ESAB India has a better ROE than the average (11%) in the Machinery industry.

That is a good sign. I usually take a closer look when a company has a better ROE than industry peers. One data point to check is if insiders have bought shares recently.

Why You Should Consider Debt When Looking At ROE

Virtually all companies need money to invest in the business, to grow profits. That cash can come from issuing shares, retained earnings, or debt. In the first and second cases, the ROE will reflect this use of cash for investment in the business. In the latter case, the debt used for growth will improve returns, but won't affect the total equity. In this manner the use of debt will boost ROE, even though the core economics of the business stay the same.

Combining ESAB India's Debt And Its 22% Return On Equity

ESAB India is free of net debt, which is a positive for shareholders. Its respectable ROE suggests it is a business worth watching, but it's even better the company achieved this without leverage. After all, when a company has a strong balance sheet, it can often find ways to invest in growth, even if it takes some time.