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 Shenzhou International Group Holdings Limited (HKG:2313), by way of a worked example.

Our data shows Shenzhou International Group Holdings has a return on equity of 20% for the last year. Another way to think of that is that for every HK$1 worth of equity in the company, it was able to earn HK$0.20.

See our latest analysis for Shenzhou International Group Holdings

How Do You Calculate Return On Equity?

The formula for ROE is:

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

Or for Shenzhou International Group Holdings:

20% = CN¥4.7b ÷ CN¥24b (Based on the trailing twelve months to June 2019.)

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 the capital paid in by shareholders, plus any retained earnings. The easiest way to calculate shareholders' equity is to subtract the company's total liabilities from the total assets.

What Does ROE 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. A higher profit will lead to a higher ROE. So, all else equal, investors should like a high ROE. That means ROE can be used to compare two businesses.

Does Shenzhou International Group Holdings 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. Importantly, this is far from a perfect measure, because companies differ significantly within the same industry classification. As you can see in the graphic below, Shenzhou International Group Holdings has a higher ROE than the average (9.7%) in the Luxury industry.

That is a good sign. We think a high ROE, alone, is usually enough to justify further research into a company. For example you might check if insiders are buying shares.

Why You Should Consider Debt When Looking At ROE

Most companies need money -- from somewhere -- to grow their 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 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.