Stock Analysis

Should Supergas Energy Ltd (TLV:SPGE) Focus On Improving This Fundamental Metric?

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TASE:ELCP
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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 Supergas Energy Ltd (TLV:SPGE), 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. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Supergas Energy

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 Supergas Energy is:

19% = ₪67m ÷ ₪346m (Based on the trailing twelve months to December 2019).

The 'return' is the yearly profit. Another way to think of that is that for every ₪1 worth of equity, the company was able to earn ₪0.19 in profit.

Does Supergas Energy Have A Good Return On Equity?

Arguably the easiest way to assess company's ROE is to compare it with the average in its industry. The limitation of this approach is that some companies are quite different from others, even within the same industry classification. As shown in the graphic below, Supergas Energy has a lower ROE than the average (25%) in the Oil and Gas industry classification.

roe
TASE:SPGE Return on Equity November 17th 2020

That certainly isn't ideal. However, a low ROE is not always bad. If the company's debt levels are moderate to low, then there's still a chance that returns can be improved via the use of financial leverage. A company with high debt levels and low ROE is a combination we like to avoid given the risk involved. Our risks dashboard should have the 3 risks we have identified for Supergas Energy.

Why You Should Consider Debt When Looking At ROE

Virtually all companies need money to invest in the business, to grow 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. That will make the ROE look better than if no debt was used.

Supergas Energy's Debt And Its 19% ROE

Supergas Energy does use a high amount of debt to increase returns. It has a debt to equity ratio of 2.02. While its ROE is pretty respectable, the amount of debt the company is carrying currently is not ideal. Debt increases risk and reduces options for the company in the future, so you generally want to see some good returns from using it.

Summary

Return on equity is useful for comparing the quality of different businesses. A company that can achieve a high return on equity without debt could be considered a high quality business. If two companies have the same ROE, then I would generally prefer the one with less debt.

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

But note: Supergas Energy 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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