A Closer Look At Kim Teck Cheong Consolidated Berhad's (KLSE:KTC) Uninspiring ROE

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 Kim Teck Cheong Consolidated Berhad (KLSE:KTC), 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Kim Teck Cheong Consolidated Berhad

How Do You 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 Kim Teck Cheong Consolidated Berhad is:

3.8% = RM4.5m ÷ RM119m (Based on the trailing twelve months to September 2020).

The 'return' refers to a company's earnings over the last year. That means that for every MYR1 worth of shareholders' equity, the company generated MYR0.04 in profit.

Does Kim Teck Cheong Consolidated Berhad 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. If you look at the image below, you can see Kim Teck Cheong Consolidated Berhad has a lower ROE than the average (8.9%) in the Consumer Retailing industry classification.

Unfortunately, that's sub-optimal. 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. When a company has low ROE but high debt levels, we would be cautious as the risk involved is too high. To know the 4 risks we have identified for Kim Teck Cheong Consolidated Berhad visit our risks dashboard for free.

How Does Debt Impact Return On Equity?

Virtually all companies need money to invest in the business, to grow profits. That cash can come from issuing shares, retained earnings, or debt. In the first two cases, the ROE will capture this use of capital to grow. In the latter case, the debt required for growth will boost returns, but will not impact the shareholders' equity. That will make the ROE look better than if no debt was used.

Kim Teck Cheong Consolidated Berhad's Debt And Its 3.8% ROE

Kim Teck Cheong Consolidated Berhad does use a high amount of debt to increase returns. It has a debt to equity ratio of 1.29. Its ROE is quite low, even with the use of significant debt; that's not a good result, in our opinion. 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 one way we can compare its business quality of different companies. 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.

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. Check the past profit growth by Kim Teck Cheong Consolidated Berhad by looking at this visualization of past earnings, revenue and cash flow.

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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