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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). To keep the lesson grounded in practicality, we'll use ROE to better understand Asian Hotels (West) Limited (NSE:AHLWEST).
Our data shows Asian Hotels (West) has a return on equity of 61% for the last year. One way to conceptualize this, is that for each ₹1 of shareholders' equity it has, the company made ₹0.61 in profit.
See our latest analysis for Asian Hotels (West)
How Do You Calculate ROE?
The formula for return on equity is:
Return on Equity = Net Profit ÷ Shareholders' Equity
Or for Asian Hotels (West):
61% = ₹748m ÷ ₹1.2b (Based on the trailing twelve months to March 2019.)
It's easy to understand the 'net profit' part of that equation, but 'shareholders' equity' requires further explanation. It is the capital paid in by shareholders, plus any retained earnings. You can calculate shareholders' equity by subtracting the company's total liabilities from its total assets.
What Does Return On Equity Signify?
ROE measures a company's profitability against the profit it retains, and any outside investments. The 'return' is the profit over the last twelve months. 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 ROE can be used to compare two businesses.
Does Asian Hotels (West) Have A Good Return On Equity?
One simple way to determine if a company has a good return on equity is to compare it to the average for its industry. The limitation of this approach is that some companies are quite different from others, even within the same industry classification. Pleasingly, Asian Hotels (West) has a superior ROE than the average (7.7%) company in the Hospitality industry.
That's what I like to see. 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.
The Importance Of Debt To Return On Equity
Companies usually need to invest money 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 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.
Combining Asian Hotels (West)'s Debt And Its 61% Return On Equity
We think Asian Hotels (West) uses a lot of debt to boost returns, as it has a relatively high debt to equity ratio of 6.49. So although the company has an impressive ROE, that figure would be a lot lower without the use of debt.