While some investors are already well versed in financial metrics (hat tip), this article is for those who would like to learn about Return On Equity (ROE) and why it is important. By way of learning-by-doing, we’ll look at ROE to gain a better understanding HEC Infra Projects Limited (NSE:HECPROJECT).
Our data shows HEC Infra Projects has a return on equity of 13% for the last year. That means that for every ₹1 worth of shareholders’ equity, it generated ₹0.13 in profit.
View our latest analysis for HEC Infra Projects
How Do I Calculate ROE?
The formula for ROE is:
Return on Equity = Net Profit ÷ Shareholders’ Equity
Or for HEC Infra Projects:
13% = 35.546447 ÷ ₹277m (Based on the trailing twelve months to September 2018.)
Most readers would understand what net profit is, but it’s worth explaining the concept of shareholders’ equity. It is all earnings retained by the company, plus any capital paid in by shareholders. The easiest way to calculate shareholders’ equity is to subtract the company’s total liabilities from the total assets.
What Does ROE Mean?
Return on Equity measures a company’s profitability against the profit it has kept for the business (plus any capital injections). 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. That means it can be interesting to compare the ROE of different companies.
Does HEC Infra Projects 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. The limitation of this approach is that some companies are quite different from others, even within the same industry classification. As is clear from the image below, HEC Infra Projects has a better ROE than the average (8.7%) in the construction industry.
That’s clearly a positive. In my book, a high ROE almost always warrants a closer look. For example you might check if insiders are buying shares.
The Importance Of Debt To Return On Equity
Virtually all companies need money to invest in the business, to grow profits. That cash can come from retained earnings, issuing new shares (equity), or debt. In the first two cases, the ROE will capture this use of capital to grow. In the latter case, the debt used for growth will improve returns, but won’t affect the total equity. Thus the use of debt can improve ROE, albeit along with extra risk in the case of stormy weather, metaphorically speaking.
HEC Infra Projects’s Debt And Its 13% ROE
HEC Infra Projects clearly uses a significant amount debt to boost returns, as it has a debt to equity ratio of 1.04. While the ROE isn’t too bad, it would probably be a lot lower if the company was forced to reduce debt. Investors should think carefully about how a company might perform if it was unable to borrow so easily, because credit markets do change over time.