What Companhiade Eletricidade do Estado da Bahia - COELBA's (BVMF:CEEB3) ROE Can Tell Us

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. We'll use ROE to examine Companhiade Eletricidade do Estado da Bahia - COELBA (BVMF:CEEB3), 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Companhiade Eletricidade do Estado da Bahia - COELBA

How Do You Calculate Return On Equity?

Return on equity 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 Companhiade Eletricidade do Estado da Bahia - COELBA is:

17% = R$1.0b ÷ R$6.0b (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. That means that for every R$1 worth of shareholders' equity, the company generated R$0.17 in profit.

Does Companhiade Eletricidade do Estado da Bahia - COELBA 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. The image below shows that Companhiade Eletricidade do Estado da Bahia - COELBA has an ROE that is roughly in line with the Electric Utilities industry average (16%).

That isn't amazing, but it is respectable. Although the ROE is similar to the industry, we should still perform further checks to see if the company's ROE is being boosted by high debt levels. If so, this increases its exposure to financial risk.

How Does Debt Impact ROE?

Companies usually need to invest money to grow their profits. That cash can come from issuing shares, retained earnings, or debt. In the case of the first and second options, the ROE will reflect this use of cash, for growth. In the latter case, the debt used for growth will improve returns, but won't affect the total equity. In this manner the use of debt will boost ROE, even though the core economics of the business stay the same.

Companhiade Eletricidade do Estado da Bahia - COELBA's Debt And Its 17% ROE

It's worth noting the high use of debt by Companhiade Eletricidade do Estado da Bahia - COELBA, leading to its debt to equity ratio of 1.39. Its ROE is quite low, even with the use of significant debt; that's not a good result, in our opinion. Investors should think carefully about how a company might perform if it was unable to borrow so easily, because credit markets do change over time.

Conclusion

Return on equity is a useful indicator of the ability of a business to generate profits and return them to shareholders. Companies that can achieve high returns on equity without too much debt are generally of good quality. 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. Check the past profit growth by Companhiade Eletricidade do Estado da Bahia - COELBA by looking at this visualization of past earnings, revenue and cash flow.

But note: Companhiade Eletricidade do Estado da Bahia - COELBA 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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