A Closer Look At Aeris Indústria e Comércio de Equipamentos para Geração de Energia S.A.'s (BVMF:AERI3) Impressive ROE

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. To keep the lesson grounded in practicality, we'll use ROE to better understand Aeris Indústria e Comércio de Equipamentos para Geração de Energia S.A. (BVMF:AERI3).

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Aeris Indústria e Comércio de Equipamentos para Geração de Energia

How Do You Calculate Return On Equity?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Aeris Indústria e Comércio de Equipamentos para Geração de Energia is:

12% = R$113m ÷ R$966m (Based on the trailing twelve months to December 2020).

The 'return' is the profit over the last twelve months. So, this means that for every R$1 of its shareholder's investments, the company generates a profit of R$0.12.

Does Aeris Indústria e Comércio de Equipamentos para Geração de Energia 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. As is clear from the image below, Aeris Indústria e Comércio de Equipamentos para Geração de Energia has a better ROE than the average (8.0%) in the Electrical industry.

That's what we like to see. However, bear in mind that a high ROE doesn’t necessarily indicate efficient profit generation. A higher proportion of debt in a company's capital structure may also result in a high ROE, where the high debt levels could be a huge risk . You can see the 4 risks we have identified for Aeris Indústria e Comércio de Equipamentos para Geração de Energia by visiting our risks dashboard for free on our platform here.

How Does Debt Impact Return On Equity?

Companies usually need to invest money to grow their profits. The cash for investment can come from prior year profits (retained earnings), issuing new shares, or borrowing. 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.

Aeris Indústria e Comércio de Equipamentos para Geração de Energia's Debt And Its 12% ROE

Aeris Indústria e Comércio de Equipamentos para Geração de Energia does use a high amount of debt to increase returns. It has a debt to equity ratio of 1.18. Its ROE is quite low, even with the use of significant debt; that's not a good result, in our opinion. Debt increases risk and reduces options for the company in the future, so you generally want to see some good returns from using it.

Summary

Return on equity is useful for comparing the quality of different businesses. In our books, the highest quality companies have high return on equity, despite low debt. If two companies have the same ROE, then I would generally prefer the one with less debt.

But ROE is just one piece of a bigger puzzle, since high quality businesses often trade on high multiples of earnings. Profit growth rates, versus the expectations reflected in the price of the stock, are a particularly important to consider. So you might want to take a peek at this data-rich interactive graph of forecasts for the company.

But note: Aeris Indústria e Comércio de Equipamentos para Geração de Energia may not be the best stock to buy. So take a peek at this free list of interesting companies with high ROE 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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