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Is Kofola CeskoSlovensko a.s.'s (SEP:KOFOL) 14% ROE Better Than Average?
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 Kofola CeskoSlovensko a.s. (SEP:KOFOL), by way of a worked example.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
Check out our latest analysis for Kofola CeskoSlovensko
How To Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Kofola CeskoSlovensko is:
14% = Kč241m ÷ Kč1.8b (Based on the trailing twelve months to September 2020).
The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every CZK1 worth of equity, the company was able to earn CZK0.14 in profit.
Does Kofola CeskoSlovensko Have A Good ROE?
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, Kofola CeskoSlovensko has a better ROE than the average (8.0%) in the Beverage industry.
That is a good sign. Bear in mind, a high ROE doesn't always mean superior financial performance. Aside from changes in net income, a high ROE can also be the outcome of high debt relative to equity, which indicates risk. You can see the 2 risks we have identified for Kofola CeskoSlovensko by visiting our risks dashboard for free on our platform here.
How Does Debt Impact ROE?
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 two cases, the ROE will capture this use of capital to grow. 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.
Combining Kofola CeskoSlovensko's Debt And Its 14% Return On Equity
It's worth noting the high use of debt by Kofola CeskoSlovensko, leading to its debt to equity ratio of 2.17. 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.
Conclusion
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. All else being equal, a higher ROE is better.
But ROE is just one piece of a bigger puzzle, since high quality businesses often trade on high multiples of earnings. It is important to consider other factors, such as future profit growth -- and how much investment is required going forward. So you might want to take a peek at this data-rich interactive graph of 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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About SEP:KOFOL
Kofola CeskoSlovensko
Produces and distributes non-alcoholic beverages in the Czech Republic, Slovakia, Slovenia, Croatia, Poland, and internationally.
Solid track record and good value.