Does Sinopec Oilfield Service Corporation (HKG:1033) Create Value For Shareholders?

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). We'll use ROE to examine Sinopec Oilfield Service Corporation (HKG:1033), by way of a worked example.

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 Sinopec Oilfield Service

How To 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 Sinopec Oilfield Service is:

5.8% = CN¥423m ÷ CN¥7.3b (Based on the trailing twelve months to September 2020).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every HK$1 of its shareholder's investments, the company generates a profit of HK$0.06.

Does Sinopec Oilfield Service 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 Sinopec Oilfield Service has an ROE that is roughly in line with the Energy Services industry average (5.8%).

That isn't amazing, but it is respectable. While at least the ROE is not lower than the industry, its still worth checking what role the company's debt plays as high debt levels relative to equity may also make the ROE appear high. If so, this increases its exposure to financial risk. To know the 2 risks we have identified for Sinopec Oilfield Service visit our risks dashboard for free.

The Importance Of Debt To Return On Equity

Virtually all companies need money to invest in the business, to grow profits. That cash can come from retained earnings, issuing new shares (equity), 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. Thus the use of debt can improve ROE, albeit along with extra risk in the case of stormy weather, metaphorically speaking.

Combining Sinopec Oilfield Service's Debt And Its 5.8% Return On Equity

Sinopec Oilfield Service clearly uses a high amount of debt to boost returns, as it has a debt to equity ratio of 2.97. Its ROE is quite low, even with the use of significant debt; that's not a good result, in our opinion. Debt does bring extra risk, so it's only really worthwhile when a company generates some decent returns from it.

Conclusion

Return on equity is a useful indicator of the ability of a business to generate profits and return them to shareholders. 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.

Having said that, while ROE is a useful indicator of business quality, you'll have to look at a whole range of factors to determine the right price to buy a stock. 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 you might want to check this FREE visualization of analyst forecasts for the company.

But note: Sinopec Oilfield Service 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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