Should You Be Excited About Kopy Goldfields AB (publ)'s (STO:KOPY) 25% Return On Equity?

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. To keep the lesson grounded in practicality, we'll use ROE to better understand Kopy Goldfields AB (publ) (STO:KOPY).

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Kopy Goldfields

How Is ROE Calculated?

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 Kopy Goldfields is:

25% = kr137m ÷ kr555m (Based on the trailing twelve months to June 2020).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each SEK1 of shareholders' capital it has, the company made SEK0.25 in profit.

Does Kopy Goldfields 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. The limitation of this approach is that some companies are quite different from others, even within the same industry classification. As is clear from the image below, Kopy Goldfields has a better ROE than the average (8.8%) in the Metals and Mining industry.

That's what we like to see. Bear in mind, a high ROE doesn't always mean superior financial performance. Aside from changes in net income, a high ROE can also be the outcome of high debt relative to equity, which indicates risk. You can see the 2 risks we have identified for Kopy Goldfields by visiting our risks dashboard for free on our platform here.

How Does Debt Impact ROE?

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 first and second cases, the ROE will reflect this use of cash for investment in the business. In the latter case, the use of debt will improve the returns, but will not change the equity. In this manner the use of debt will boost ROE, even though the core economics of the business stay the same.

Combining Kopy Goldfields' Debt And Its 25% Return On Equity

One positive for shareholders is that Kopy Goldfields does not have any net debt! Its high ROE indicates the business is high quality, but the fact that this was achieved without leverage is veritably impressive. After all, with cash on the balance sheet, a company has a lot more optionality in good times and bad.

Conclusion

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 around the same level of debt to equity, and one has a higher ROE, I'd generally prefer the one with higher ROE.

But ROE is just one piece of a bigger puzzle, since high quality businesses often trade on high multiples of earnings. Profit growth rates, versus the expectations reflected in the price of the stock, are a particularly important to consider. Check the past profit growth by Kopy Goldfields by looking at this visualization of past earnings, revenue and cash flow.

Of course Kopy Goldfields may not be the best stock to buy. So you may wish to see this free collection of other companies that have 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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