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. To keep the lesson grounded in practicality, we’ll use ROE to better understand Sun Hung Kai Properties Limited (HKG:16).
Sun Hung Kai Properties has a ROE of 9.3%, 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$0.093 in profit.
View our latest analysis for Sun Hung Kai Properties
How Do I Calculate ROE?
The formula for ROE is:
Return on Equity = Net Profit ÷ Shareholders’ Equity
Or for Sun Hung Kai Properties:
9.3% = HK$50.0b ÷ HK$548.4b (Based on the trailing twelve months to June 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 looks at the amount a company earns relative to the money it has kept within the business. The ‘return’ is the profit over the last twelve months. A higher profit will lead to a a higher ROE. So, all else being equal, a high ROE is better than a low one. That means it can be interesting to compare the ROE of different companies.
Does Sun Hung Kai Properties 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. The image below shows that Sun Hung Kai Properties has an ROE that is roughly in line with the real estate industry average (9.3%).
That isn’t amazing, but it is respectable. Of course, this year’s ROE might be a product of last year’s decisions. So it makes sense to check how long the board and CEO have been in place.
Why You Should Consider Debt When Looking At ROE
Most companies need money — from somewhere — to grow their profits. The cash for investment can come from prior year profits (retained earnings), issuing new shares, or borrowing. In the case of the first and second options, the ROE will reflect this use of cash, for growth. In the latter case, the use of debt will improve the returns, but will not change the equity. In this manner the use of debt will boost ROE, even though the core economics of the business stay the same.