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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). We'll use ROE to examine Del Monte Pacific Limited (SGX:D03), by way of a worked example.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
Check out our latest analysis for Del Monte Pacific
How Is ROE Calculated?
ROE can be calculated by using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Del Monte Pacific is:
16% = US$59m ÷ US$375m (Based on the trailing twelve months to January 2023).
The 'return' is the yearly profit. That means that for every SGD1 worth of shareholders' equity, the company generated SGD0.16 in profit.
Does Del Monte Pacific Have A Good Return On Equity?
One simple way to determine if a company has a good return on equity is to compare it to the average for its industry. 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, Del Monte Pacific has a better ROE than the average (9.3%) in the Food industry.
That is a good sign. Bear in mind, a high ROE doesn't always mean superior financial performance. Especially when a firm uses high levels of debt to finance its debt which may boost its ROE but the high leverage puts the company at risk. To know the 4 risks we have identified for Del Monte Pacific visit our risks dashboard for free.
How Does Debt Impact ROE?
Companies usually need to invest money to grow their 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 required for growth will boost returns, but will not impact the shareholders' equity. That will make the ROE look better than if no debt was used.
Combining Del Monte Pacific's Debt And Its 16% Return On Equity
It seems that Del Monte Pacific uses a huge volume of debt to fund the business, since it has an extremely high debt to equity ratio of 5.88. Its ROE is respectable, but it's not so impressive once you consider all of the debt.
Summary
Return on equity is useful for comparing the quality of different businesses. A company that can achieve a high return on equity without debt could be considered a high quality business. All else being equal, a higher ROE is better.