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. By way of learning-by-doing, we’ll look at ROE to gain a better understanding of SW Umwelttechnik Stoiser & Wolschner AG (VIE:SWUT).
Return on equity or ROE is a key measure used to assess how efficiently a company’s management is utilizing the company’s capital. Put another way, it reveals the company’s success at turning shareholder investments into profits.
How To Calculate Return On Equity?
ROE can be calculated by using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders’ Equity
So, based on the above formula, the ROE for SW Umwelttechnik Stoiser & Wolschner is:
49% = €8.1m ÷ €17m (Based on the trailing twelve months to December 2019).
The ‘return’ refers to a company’s earnings over the last year. One way to conceptualize this is that for each €1 of shareholders’ capital it has, the company made €0.49 in profit.
Does SW Umwelttechnik Stoiser & Wolschner 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. However, this method is only useful as a rough check, because companies do differ quite a bit within the same industry classification. Pleasingly, SW Umwelttechnik Stoiser & Wolschner has a superior ROE than the average (12%) in the Construction industry.
That’s what we like to see. However, bear in mind that a high ROE doesn’t necessarily indicate efficient profit generation. Especially when a firm uses high levels of debt to finance its debt which may boost its ROE but the high leverage puts the company at risk. To know the 4 risks we have identified for SW Umwelttechnik Stoiser & Wolschner visit our risks dashboard for free.
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 first two cases, the ROE will capture this use of capital to grow. In the latter case, the debt required for growth will boost returns, but will not impact the shareholders’ equity. That will make the ROE look better than if no debt was used.
Combining SW Umwelttechnik Stoiser & Wolschner’s Debt And Its 49% Return On Equity
It appears that SW Umwelttechnik Stoiser & Wolschner makes extensive use of debt to improve its returns, because it has an alarmingly high debt to equity ratio of 3.34. While its ROE is no doubt quite impressive, it could give a false impression about the company’s returns given that its huge debt could be boosting those returns.
Return on equity is useful for comparing the quality of different businesses. Companies that can achieve high returns on equity without too much debt are generally of good quality. All else being equal, a higher ROE is better.
Having said that, while ROE is a useful indicator of business quality, you’ll have to look at a whole range of factors to determine the right price to buy a stock. The rate at which profits are likely to grow, relative to the expectations of profit growth reflected in the current price, must be considered, too. You can see how the company has grow in the past by looking at this FREE detailed graph of past earnings, revenue and cash flow.
If you would prefer check out another company — one with potentially superior financials — then do not miss this free list of interesting companies, that have HIGH return on equity and low debt.
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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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