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 Procimmo Group AG (BRN:SEGN), by way of a worked example.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
View our latest analysis for Procimmo Group
How Is ROE Calculated?
Return on equity 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 Procimmo Group is:
36% = CHF15m ÷ CHF41m (Based on the trailing twelve months to June 2022).
The 'return' is the amount earned after tax over the last twelve months. So, this means that for every CHF1 of its shareholder's investments, the company generates a profit of CHF0.36.
Does Procimmo Group Have A Good Return On Equity?
By comparing a company's ROE with its industry average, we can get a quick measure of how good it is. 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, Procimmo Group has a better ROE than the average (8.9%) in the Real Estate industry.
That's what we like to see. Bear in mind, a high ROE doesn't always mean superior financial performance. Aside from changes in net income, a high ROE can also be the outcome of high debt relative to equity, which indicates risk. You can see the 4 risks we have identified for Procimmo Group by visiting our risks dashboard for free on our platform here.
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 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 use of debt will improve the returns, but will not change the equity. That will make the ROE look better than if no debt was used.
Combining Procimmo Group's Debt And Its 36% Return On Equity
Procimmo Group clearly uses a high amount of debt to boost returns, as it has a debt to equity ratio of 1.21. There's no doubt the ROE is impressive, but it's worth keeping in mind that the metric could have been lower if the company were to reduce its debt. Debt does bring extra risk, so it's only really worthwhile when a company generates some decent returns from it.