Is Frey SA's (EPA:FREY) 7.5% 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 Frey SA (EPA:FREY), by way of a worked example.

Over the last twelve months Frey has recorded a ROE of 7.5%. That means that for every €1 worth of shareholders' equity, it generated €0.075 in profit.

Check out our latest analysis for Frey

How Do I Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit ÷ Shareholders' Equity

Or for Frey:

7.5% = €45m ÷ €601m (Based on the trailing twelve months to December 2018.)

Most know that net profit is the total earnings after all expenses, but the concept of shareholders' equity is a little more complicated. It is the capital paid in by shareholders, plus any retained earnings. The easiest way to calculate shareholders' equity is to subtract the company's total liabilities from the total assets.

What Does ROE Mean?

ROE looks at the amount a company earns relative to the money it has kept within the business. The 'return' is the profit over the last twelve months. A higher profit will lead to a higher ROE. So, as a general rule, a high ROE is a good thing. That means it can be interesting to compare the ROE of different companies.

Does Frey 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. If you look at the image below, you can see Frey has a similar ROE to the average in the REITs industry classification (8.3%).

That's not overly surprising. ROE tells us about the quality of the business, but it does not give us much of an idea if the share price is cheap. If you are like me, then you will not want to miss this freelist of growing companies that insiders are buying.

The Importance Of Debt To Return On Equity

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 use of debt will improve the returns, but will not change the equity. In this manner the use of debt will boost ROE, even though the core economics of the business stay the same.

Frey's Debt And Its 7.5% ROE

Frey has a debt to equity ratio of 0.54, which is far from excessive. Although the ROE isn't overly impressive, the debt load is modest, suggesting the business has potential. Conservative use of debt to boost returns is usually a good move for shareholders, though it does leave the company more exposed to interest rate rises.

In Summary

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. 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. 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. So I think it may be worth checking this freethis detailed graph of past earnings, revenue and cash flow .

Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this freelist of interesting companies.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.