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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). By way of learning-by-doing, we'll look at ROE to gain a better understanding of Tongfang Kontafarma Holdings Limited (HKG:1312).

Tongfang Kontafarma Holdings has a ROE of 3.7%, based on the last twelve months. Another way to think of that is that for every HK$1 worth of equity in the company, it was able to earn HK$0.037.

See our latest analysis for Tongfang Kontafarma Holdings

How Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit ÷ Shareholders' Equity

Or for Tongfang Kontafarma Holdings:

3.7% = HK$32m ÷ HK$1.9b (Based on the trailing twelve months to December 2018.)

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 yearly profit. That means that the higher the ROE, the more profitable the company is. So, as a general rule, a high ROE is a good thing. That means it can be interesting to compare the ROE of different companies.

Does Tongfang Kontafarma Holdings Have A Good Return On Equity?

Arguably the easiest way to assess company's ROE is to compare it with the average in its industry. Importantly, this is far from a perfect measure, because companies differ significantly within the same industry classification. As shown in the graphic below, Tongfang Kontafarma Holdings has a lower ROE than the average (13%) in the Basic Materials industry classification.

That certainly isn't ideal. We prefer it when the ROE of a company is above the industry average, but it's not the be-all and end-all if it is lower. Nonetheless, it could be useful to double-check if insiders have sold shares recently.

The Importance Of Debt To Return On Equity

Virtually all companies need money to invest in the business, to grow profits. That cash can come from issuing shares, retained earnings, or debt. In the case of the first and second options, the ROE will reflect this use of cash, for growth. In the latter case, the debt used for growth will improve returns, but won't affect the total equity. In this manner the use of debt will boost ROE, even though the core economics of the business stay the same.