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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 Bâloise Holding AG (VTX:BALN).
Over the last twelve months Bâloise Holding has recorded a ROE of 9.8%. That means that for every CHF1 worth of shareholders' equity, it generated CHF0.10 in profit.
Check out our latest analysis for Bâloise Holding
How Do You Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit ÷ Shareholders' Equity
Or for Bâloise Holding:
9.8% = CHF649m ÷ CHF6.6b (Based on the trailing twelve months to June 2019.)
Most know that net profit is the total earnings after all expenses, but the concept of shareholders' equity is a little more complicated. It is the capital paid in by shareholders, plus any retained earnings. You can calculate shareholders' equity by subtracting the company's total liabilities from its total assets.
What Does Return On Equity Mean?
ROE looks at the amount a company earns relative to the money it has kept within the business. The 'return' is the yearly profit. A higher profit will lead to a higher ROE. So, all else being equal, a high ROE is better than a low one. Clearly, then, one can use ROE to compare different companies.
Does Bâloise Holding Have A Good ROE?
One simple way to determine if a company has a good return on equity is to compare it to the average for its industry. Importantly, this is far from a perfect measure, because companies differ significantly within the same industry classification. As you can see in the graphic below, Bâloise Holding has a higher ROE than the average (7.4%) in the Insurance 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.
The Importance Of Debt To Return On Equity
Most companies need money -- from somewhere -- to grow their profits. That cash can come from retained earnings, issuing new shares (equity), 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 Bâloise Holding's Debt And Its 9.8% Return On Equity
While Bâloise Holding does have some debt, with debt to equity of just 0.28, we wouldn't say debt is excessive. I'm not impressed with its ROE, but the debt levels are not too high, indicating the business has decent prospects. Careful use of debt to boost returns is often very good for shareholders. However, it could reduce the company's ability to take advantage of future opportunities.