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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 ZEAL Network SE (ETR:TIM), by way of a worked example.
Over the last twelve months ZEAL Network has recorded a ROE of 21%. That means that for every €1 worth of shareholders' equity, it generated €0.21 in profit.
Check out our latest analysis for ZEAL Network
How Do I Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit ÷ Shareholders' Equity
Or for ZEAL Network:
21% = €27m ÷ €130m (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. The easiest way to calculate shareholders' equity is to subtract the company's total liabilities from the 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 yearly profit. That means that the higher the ROE, the more profitable the company is. So, all else equal, investors should like a high ROE. That means ROE can be used to compare two businesses.
Does ZEAL Network Have A Good ROE?
One simple way to determine if a company has a good return on equity is to compare it to the average for its industry. 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, ZEAL Network has a higher ROE than the average (17%) in the Hospitality industry.
That's clearly a positive. In my book, a high ROE almost always warrants a closer look. For example you might check if insiders are buying shares.
How Does Debt Impact ROE?
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 two cases, the ROE will capture this use of capital to grow. 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.
ZEAL Network's Debt And Its 21% ROE
Shareholders will be pleased to learn that ZEAL Network has not one iota of net debt! Its impressive ROE suggests it is a high quality business, but it's even better to have achieved that without leverage. After all, with cash on the balance sheet, a company has a lot more optionality in good times and bad.