Many investors are still educating themselves about the various metrics that can be useful when analyzing a stock. This article is for those who want to learn more about return on equity (ROE). As a learning-by-doing, we’ll take a look at the ROE to better understand Macau E&M Holding Limited (HKG: 1408).
Return on equity or ROE is an important factor for a shareholder to consider because it tells them how efficiently their capital is being reinvested. In simpler terms, it measures a company’s profitability relative to equity.
Check out our latest analysis for Macao E&M Holding
How do you calculate return on equity?
the return on equity formula is:
Return on equity = Net income (from continuing operations) ÷ Equity
Thus, based on the above formula, the ROE of Macau E&M Holding is:
13% = US $ 27 million ÷ US $ 210 million (based on the last twelve months up to December 2020).
The “return” is the income the business has earned over the past year. This means that for every HK $ 1 worth of equity, the company generated HK $ 0.13 in profit.
Does Macao E&M Holding have a good return on equity?
A simple way to determine if a company has a good return on equity is to compare it to the average in its industry. It is important to note that this measure is far from perfect, as companies differ considerably within a single industry classification. As shown in the image below, Macau E&M Holding has a better ROE than the construction industry average (8.8%).
This is what we love to see. That said, high ROE doesn’t always indicate high profitability. Especially when a business uses high levels of leverage to finance its debt, which can increase its ROE, but high leverage puts the business at risk. Our risk dashboard should include the 3 risks that we have identified for Macau E&M Holding.
What is the impact of debt on ROE?
Almost all businesses need money to invest in the business, 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 use of debt will improve returns, but will not affect equity. This will make the ROE better than if no debt was used.
Combine the debt of Macao E&M Holding and its return on equity of 13%
Macau E&M Holding has no net debt, which is positive for shareholders. Its respectable ROE suggests that this is a business to watch, but it’s even better if the business got there without leverage. After all, with cash on the balance sheet, a business has many more options in good times and in bad times.
Return on equity is a useful indicator of a company’s ability to generate profits and return them to shareholders. 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 roughly the same level of debt to equity and one has a higher ROE, I would generally prefer the one with a higher ROE.
But when a company is of high quality, the market often offers it up to a price that reflects that. Especially important to consider are the growth rates of earnings, relative to expectations reflected in the share price. Check out Macau E&M Holding’s past earnings growth by viewing this visualization of past earnings, income and cash flow.
If you would rather consult with another company – one with potentially superior finances – then don’t miss this free list of interesting companies, which have a HIGH return on equity and low leverage.
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This Simply Wall St article is general in nature. 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 any of the stocks mentioned.
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