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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 Kentima Holding AB (publ) (STO:KENH), by way of a worked example.
Kentima Holding has a ROE of 17%, based on the last twelve months. Another way to think of that is that for every SEK1 worth of equity in the company, it was able to earn SEK0.17.
See our latest analysis for Kentima Holding
How Do You Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit ÷ Shareholders’ Equity
Or for Kentima Holding:
17% = 4.497 ÷ kr27m (Based on the trailing twelve months to September 2018.)
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 looks at the amount a company earns relative to the money it has kept within the business. The ‘return’ is the amount earned after tax over the last twelve months. A higher profit will lead to a higher ROE. So, as a general rule, a high ROE is a good thing. That means ROE can be used to compare two businesses.
Does Kentima Holding Have A Good ROE?
Arguably the easiest way to assess company’s ROE is to compare it with the average in its industry. The limitation of this approach is that some companies are quite different from others, even within the same industry classification. The image below shows that Kentima Holding has an ROE that is roughly in line with the Software industry average (16%).
That isn’t amazing, but it is respectable. ROE can give us a view about company quality, but many investors also look to other factors, such as whether there are insiders buying shares. If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
How Does Debt Impact Return On Equity?
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 case of the first and second options, the ROE will reflect this use of cash, for growth. 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.