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While some investors are already well versed in financial metrics (hat tip), this article is for those who would like to learn about Return On Equity (ROE) and why it is important. We’ll use ROE to examine FuturAqua Ásványvíztermelo és Vagyonkezelo Nyilvánosan Muködo Részvénytársaság (BUSE:FUTURAQUA), by way of a worked example.
Our data shows FuturAqua Ásványvíztermelo és Vagyonkezelo Nyilvánosan Muködo Részvénytársaság has a return on equity of 7.6% for the last year. One way to conceptualize this, is that for each HUF1 of shareholders’ equity it has, the company made HUF0.076 in profit.
How Do You Calculate ROE?
The formula for return on equity is:
Return on Equity = Net Profit ÷ Shareholders’ Equity
Or for FuturAqua Ásványvíztermelo és Vagyonkezelo Nyilvánosan Muködo Részvénytársaság:
7.6% = Ft11m ÷ Ft151m (Based on the trailing twelve months to December 2018.)
Most readers would understand what net profit is, but it’s worth explaining the concept of shareholders’ equity. It is the capital paid in by shareholders, plus any retained earnings. Shareholders’ equity can be calculated by subtracting the total liabilities of the company from the total assets of the company.
What Does ROE Signify?
ROE measures a company’s profitability against the profit it retains, and any outside investments. The ‘return’ is the amount earned after tax over the last twelve months. The higher the ROE, the more profit the company is making. So, all else being equal, a high ROE is better than a low one. That means it can be interesting to compare the ROE of different companies.
Does FuturAqua Ásványvíztermelo és Vagyonkezelo Nyilvánosan Muködo Részvénytársaság 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. As is clear from the image below, FuturAqua Ásványvíztermelo és Vagyonkezelo Nyilvánosan Muködo Részvénytársaság has a lower ROE than the average (11%) in the Beverage industry.
That’s not what we like to see. It is better when the ROE is above industry average, but a low one doesn’t necessarily mean the business is overpriced. Nonetheless, it might be wise to check if insiders have been selling.
Why You Should Consider Debt When Looking At 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 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.
FuturAqua Ásványvíztermelo és Vagyonkezelo Nyilvánosan Muködo Részvénytársaság’s Debt And Its 7.6% ROE
Although FuturAqua Ásványvíztermelo és Vagyonkezelo Nyilvánosan Muködo Részvénytársaság does use a little debt, its debt to equity ratio of just 0.059 is very low. Although the ROE isn’t overly impressive, the debt load is modest, suggesting the business has potential. Judicious use of debt to improve returns can certainly be a good thing, although it does elevate risk slightly and reduce future optionality.
Return on equity is one way we can compare the business quality of different companies. A company that can achieve a high return on equity without debt could be considered a high quality business. All else being equal, a higher ROE is better.
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. It is important to consider other factors, such as future profit growth — and how much investment is required going forward. So I think it may be worth checking this free this 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 free list 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 firstname.lastname@example.org. 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.