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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). We'll use ROE to examine Wolters Kluwer N.V. (AMS:WKL), by way of a worked example.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Put another way, it reveals the company's success at turning shareholder investments into profits.
Check out our latest analysis for Wolters Kluwer
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Wolters Kluwer is:
70% = €1.1b ÷ €1.5b (Based on the trailing twelve months to December 2024).
The 'return' is the yearly profit. Another way to think of that is that for every €1 worth of equity, the company was able to earn €0.70 in profit.
Does Wolters Kluwer 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. However, this method is only useful as a rough check, because companies do differ quite a bit within the same industry classification. Pleasingly, Wolters Kluwer has a superior ROE than the average (20%) in the Professional Services industry.
That's clearly a positive. 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.
The Importance Of Debt To Return On Equity
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 debt used for growth will improve returns, but won't affect the total equity. Thus the use of debt can improve ROE, albeit along with extra risk in the case of stormy weather, metaphorically speaking.
Combining Wolters Kluwer's Debt And Its 70% Return On Equity
Wolters Kluwer does use a high amount of debt to increase returns. It has a debt to equity ratio of 2.49. While no doubt that its ROE is impressive, we would have been even more impressed had the company achieved this with lower debt. Debt does bring extra risk, so it's only really worthwhile when a company generates some decent returns from it.