Should You Be Excited About Pick n Pay Stores Limited's (JSE:PIK) 29% Return On Equity?

By
Simply Wall St
Published
September 06, 2021
JSE:PIK
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). We'll use ROE to examine Pick n Pay Stores Limited (JSE:PIK), by way of a worked example.

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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Pick n Pay Stores

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 Pick n Pay Stores is:

29% = R967m ÷ R3.4b (Based on the trailing twelve months to February 2021).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each ZAR1 of shareholders' capital it has, the company made ZAR0.29 in profit.

Does Pick n Pay Stores 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. However, this method is only useful as a rough check, because companies do differ quite a bit within the same industry classification. Pleasingly, Pick n Pay Stores has a superior ROE than the average (23%) in the Consumer Retailing industry.

roe
JSE:PIK Return on Equity September 7th 2021

That is a good sign. However, bear in mind that a high ROE doesn’t necessarily indicate efficient profit generation. Especially when a firm uses high levels of debt to finance its debt which may boost its ROE but the high leverage puts the company at risk. Our risks dashboardshould have the 2 risks we have identified for Pick n Pay Stores.

How Does Debt Impact Return On Equity?

Companies usually need to invest money to grow their profits. That cash can come from retained earnings, issuing new shares (equity), or debt. In the first two cases, the ROE will capture this use of capital to grow. 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.

Pick n Pay Stores' Debt And Its 29% ROE

Pick n Pay Stores clearly uses a high amount of debt to boost returns, as it has a debt to equity ratio of 1.56. While its ROE is pretty respectable, the amount of debt the company is carrying currently is not ideal. Debt does bring extra risk, so it's only really worthwhile when a company generates some decent returns from it.

Conclusion

Return on equity is useful for comparing the quality of different businesses. Companies that can achieve high returns on equity without too much debt are generally of good quality. 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. 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.

But note: Pick n Pay Stores 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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