Boasting A 19% Return On Equity, Is Mota-Engil, SGPS, S.A. (ELI:EGL) A Top Quality Stock?

By
Simply Wall St
Published
March 15, 2022
ENXTLS:EGL
Source: Shutterstock

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). By way of learning-by-doing, we'll look at ROE to gain a better understanding of Mota-Engil, SGPS, S.A. (ELI:EGL).

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Mota-Engil SGPS

How Is ROE Calculated?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Mota-Engil SGPS is:

19% = €61m ÷ €323m (Based on the trailing twelve months to December 2021).

The 'return' is the amount earned after tax over the last twelve months. That means that for every €1 worth of shareholders' equity, the company generated €0.19 in profit.

Does Mota-Engil SGPS 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. Importantly, this is far from a perfect measure, because companies differ significantly within the same industry classification. Pleasingly, Mota-Engil SGPS has a superior ROE than the average (11%) in the Construction industry.

roe
ENXTLS:EGL Return on Equity March 15th 2022

That's what we like to see. However, bear in mind that a high ROE doesn’t necessarily indicate efficient profit generation. A higher proportion of debt in a company's capital structure may also result in a high ROE, where the high debt levels could be a huge risk . Our risks dashboardshould have the 2 risks we have identified for Mota-Engil SGPS.

Why You Should Consider Debt When Looking At ROE

Most companies need money -- from somewhere -- to grow their 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.

Combining Mota-Engil SGPS' Debt And Its 19% Return On Equity

It seems that Mota-Engil SGPS uses a huge volume of debt to fund the business, since it has an extremely high debt to equity ratio of 7.49. Its ROE is pretty good, but given the impact of the debt, we're less than enthused, overall.

Summary

Return on equity is useful for comparing the quality of different businesses. In our books, the highest quality companies have high return on equity, despite low debt. 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 you might want to check this FREE visualization of analyst forecasts for the company.

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

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