Many investors are still learning about the various indicators that are useful when analyzing stocks. This article is for those who want to understand return on equity (ROE). To ground the lesson in practicality, we will use ROE to better understand internet infinity Inc. (TSE:6545).
ROE, or return on equity, is a useful tool for evaluating how effectively a company generates returns on the investment it receives from shareholders. In other words, it is a profitability ratio that measures the return on capital provided by a company’s shareholders.
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How is return on equity calculated?
Return on equity can be calculated using the following formula:
Return on equity = Net profit (from continuing operations) ÷ Shareholders’ equity
Therefore, according to the above formula, the unlimited ROE of the Internet is:
10% = ¥141m ÷ ¥1.4b (based on the trailing 12 months to December 2023).
The “return” is the annual profit. This means that for every $1 worth of shareholders’ equity, the company generated $0.10 in profit.
Does Internet Unlimited have a good return on equity?
One easy way to determine if a company has a good ROE is to compare it to the industry average. Importantly, this is far from a perfect measure, as companies within the same industry classification vary widely. You can see in the image below that Internet Infinity’s ROE is fairly close to the Healthcare industry average (9.0%).
This is neither particularly good nor particularly bad. Although the ROE is similar to the industry, we should further examine whether the company’s ROE is being driven by high debt levels. If so, it increases the financial risk it faces.You can visit our website to learn about the 2 risks we have identified for the Internet Infinity Risk dashboard It’s free on our platform.
How does debt affect return on equity?
Almost all companies need capital to invest in their business and increase profits. This cash can come from retained earnings, issuing new shares (equity), or debt. In the case of the first and second options, the ROE will reflect this use of cash to achieve growth. In the latter case, using debt improves returns but does not change equity. This will make the ROE look better than using no debt.
Combine internet infinity’s debt with its 10% return on equity
internet Infinity has a debt-to-equity ratio of 0.63, which is far from high. The combination of modest debt and a very respectable ROE suggests this is a business worth paying attention to. Prudent use of debt to boost returns is often very beneficial to shareholders. However, this may reduce the company’s ability to capitalize on future opportunities.
generalize
ROE is one way we compare the quality of the businesses of different companies. A company that is able to achieve a high return on equity without debt can be considered a high-quality business. If two companies have roughly the same level of debt-to-equity ratios, and one of them has a higher ROE, then I will generally prefer the company with the higher ROE.
That being said, while ROE is a useful measure of the quality of a business, you have to consider a range of factors to determine the right price to buy a stock. Profit growth compared to expectations reflected in stock prices is a particularly important consideration.So I thought it might be worth checking it out free this Detailed chart Past earnings, revenue and cash flows.
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This article from Simply Wall St is general in nature. We only use unbiased methodologies to provide commentary based on historical data and analyst forecasts, and our articles are not intended to provide financial advice. It does not constitute a recommendation to buy or sell any stock and does not take into account your objectives or your financial situation. Our goal is to provide you with long-term focused analysis driven by fundamental data. Please note that our analysis may not take into account the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any of the stocks mentioned.