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 of Precision Tsugami (China) Corporation Limited (HKG:1651).

Precision Tsugami (China) has a ROE of 17%, based on the last twelve months. One way to conceptualize this, is that for each HK$1 of shareholders' equity it has, the company made HK$0.17 in profit.

View our latest analysis for Precision Tsugami (China)

How Do I Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

Or for Precision Tsugami (China):

17% = CN¥249m ÷ CN¥1.5b (Based on the trailing twelve months to September 2019.)

Most readers would understand what net profit is, but it’s worth explaining the concept of shareholders’ equity. It is the capital paid in by shareholders, plus any retained earnings. Shareholders' equity can be calculated by subtracting the total liabilities of the company from the total assets of the company.

What Does ROE Signify?

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. 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 Precision Tsugami (China) Have A Good ROE?

Arguably the easiest way to assess company's ROE is to compare it with the average in its industry. However, this method is only useful as a rough check, because companies do differ quite a bit within the same industry classification. Pleasingly, Precision Tsugami (China) has a superior ROE than the average (9.8%) company in the Machinery industry.

That's what I like to see. I usually take a closer look when a company has a better ROE than industry peers. For example, I often check if insiders have been buying shares.

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 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. That will make the ROE look better than if no debt was used.