Can GPS Participações e Empreendimentos S.A. (BVMF:GGPS3) Maintain Its Strong Returns?

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). By way of learning-by-doing, we'll look at ROE to gain a better understanding of GPS Participações e Empreendimentos S.A. (BVMF:GGPS3).

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for GPS Participações e Empreendimentos

How Is ROE Calculated?

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 GPS Participações e Empreendimentos is:

20% = R$597m ÷ R$3.0b (Based on the trailing twelve months to September 2023).

The 'return' is the yearly profit. Another way to think of that is that for every R$1 worth of equity, the company was able to earn R$0.20 in profit.

Does GPS Participações e Empreendimentos Have A Good Return On Equity?

By comparing a company's ROE with its industry average, we can get a quick measure of how good it is. 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, GPS Participações e Empreendimentos has a better ROE than the average (12%) in the Commercial Services industry.

That's clearly a positive. 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.

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 and second cases, the ROE will reflect this use of cash for investment in the business. 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.

GPS Participações e Empreendimentos' Debt And Its 20% ROE

It's worth noting the high use of debt by GPS Participações e Empreendimentos, leading to its debt to equity ratio of 1.05. There's no doubt its ROE is decent, but the very high debt the company carries is not too exciting to see. 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 around the same level of debt to equity, and one has a higher ROE, I'd generally prefer the one with higher ROE.

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 check this FREE visualization of analyst forecasts for the company.

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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.