In This Article:
One of the best investments we can make is in our own knowledge and skill set. With that in mind, this article will work through how we can use Return On Equity (ROE) to better understand a business. We’ll use ROE to examine Onward Technologies Limited (NSE:ONWARDTEC), by way of a worked example.
Over the last twelve months Onward Technologies has recorded a ROE of 10%. That means that for every ₹1 worth of shareholders’ equity, it generated ₹0.10 in profit.
See our latest analysis for Onward Technologies
How Do I Calculate ROE?
The formula for ROE is:
Return on Equity = Net Profit ÷ Shareholders’ Equity
Or for Onward Technologies:
10% = 56.494 ÷ ₹555m (Based on the trailing twelve months to September 2018.)
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 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 Return On Equity Mean?
ROE measures a company’s profitability against the profit it retains, and any outside investments. The ‘return’ is the amount earned after tax over the last twelve months. The higher the ROE, the more profit the company is making. So, as a general rule, a high ROE is a good thing. Clearly, then, one can use ROE to compare different companies.
Does Onward Technologies Have A Good ROE?
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. The image below shows that Onward Technologies has an ROE that is roughly in line with the it industry average (11%).
That’s neither particularly good, nor bad. Generally it will take a while for decisions made by leadership to impact the ROE. So savvy investors often note how long the CEO has been in that position.
How Does Debt Impact ROE?
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 required for growth will boost returns, but will not impact the shareholders’ equity. In this manner the use of debt will boost ROE, even though the core economics of the business stay the same.