One of the best investments we can make is in our own knowledge and skills. With that in mind, this article will discuss how we can use Return on Equity (ROE) to better understand a business. As a learning-by-doing, we’ll take a look at the ROE to better understand Geekay Wires Limited (NSE: GEEKAYWIRE).
Return on equity or ROE is a test of how effectively a company increases its value and manages investor money. In other words, it is a profitability ratio that measures the rate of return on capital contributed by the shareholders of the company.
See our latest review for Geekay Wires
How to calculate return on equity?
Return on equity can be calculated using the formula:
Return on equity = Net income (from continuing operations) Ã· Equity
So, based on the above formula, the ROE of Geekay Wires is:
14% = â¹ 63m â¹ 450m (Based on the last twelve months up to June 2021).
The “return” is the annual profit. One way to conceptualize this is that for every 1 of shareholders’ capital it has, the company made 0.14 of profit.
Does Geekay Wires have a good ROE?
By comparing a company’s ROE with its industry average, we can get a quick measure of its quality. The limitation of this approach is that some companies are very different from others, even within the same industry classification. You can see in the graph below that Geekay Wires has a ROE that is fairly close to the metals and mining industry average (15%).
It is neither particularly good nor bad. Even though the ROE is respectable compared to the industry, it is worth checking out if the company’s ROE is helped by high debt levels. If so, it increases their exposure to financial risk. You can see the 3 risks we have identified for Geekay Wires by visiting our risk dashboard for free on our platform here.
Why You Should Consider Debt When Looking At ROE
Most businesses need money – from somewhere – to increase their profits. This liquidity can come from retained earnings, the issuance of new shares (shares) or debt. In the first two cases, the ROE will capture this use of capital to grow. In the latter case, the debt necessary for growth will increase returns, but will have no impact on equity. In this way, the use of debt will increase the ROE, even if the basic economy of the business remains the same.
Geekay Wires’ debt and its 14% ROE
Noteworthy is Geekay Wires’ high reliance on debt, which earned it a debt-to-equity ratio of 1.95. Its ROE is quite low, even with significant recourse to debt; this is not a good result, in our opinion. Investors should think carefully about how a business will perform if it weren’t able to borrow so easily, as credit markets change over time.
Return on equity is one way to compare the business quality of different companies. A business that can earn a high return on equity without going into debt could be considered a high quality business. If two companies have the same ROE, then I would generally prefer the one with the least amount of debt.
That said, while ROE is a useful indicator of how good a business is, you’ll need to look at a whole range of factors to determine the right price to buy a stock. It is important to take into account other factors, such as future profit growth and the amount of investment required for the future. You can see how the business has grown in the past by checking out this FREE detailed graphic past profits, income and cash flow.
Sure, you might find a fantastic investment looking elsewhere. So take a look at this free list of interesting companies.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in the mentioned stocks.
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