One of the best investments we can make is in our own knowledge and skills. With that in mind, this article will explain how we can use return on equity (ROE) to better understand a business. Learning by doing, we will look at ROE to better understand CapitaLand Investment Limited (SGX: 9CI).
Return on Equity or ROE is a test of how effectively a company increases its value and manages investors’ money. In other words, it is a profitability ratio that measures the rate of return on capital contributed by the company’s shareholders.
Check opportunities and risks within the SG Real Estate industry.
How do you calculate return on equity?
The ROE formula is:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the above formula, the ROE for CapitaLand Investment is:
6.3% = $1.2 billion ÷ $19 billion (based on trailing 12 months to June 2022).
The “yield” is the amount earned after tax over the last twelve months. This means that for every SGD1 of equity, the company generated 0.06 SGD of profit.
Does CapitaLand Investment have a good ROE?
A simple way to determine if a company has a good return on equity is to compare it to the average for its industry. It is important to note that this measure is far from perfect, as companies differ significantly within the same industry classification. The image below shows that CapitaLand Investment has an ROE which is roughly in line with the average for the real estate sector (6.5%).
So, although the ROE is not exceptional, it is at least acceptable. Although the ROE is similar to the industry, we still need to do further checks to see if the company’s ROE is being boosted by high debt levels. If so, this increases its exposure to financial risk. You can see the 3 risks we have identified for CapitaLand Investment 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. The money for the investment can come from the previous year’s earnings (retained earnings), from issuing new shares or from borrowing. In the first and second case, the ROE will reflect this use of cash for investment in the business. In the latter case, the use of debt will improve returns, but will not change equity. This will make the ROE better than if no debt was used.
CapitaLand Investment’s debt and its ROE of 6.3%
CapitaLand Investment has a debt ratio of 0.69, which is far from excessive. I’m not impressed with its ROE, but the debt levels aren’t too high, indicating the company has a decent outlook. Prudent use of debt to increase returns is often very good for shareholders. However, this could reduce the company’s ability to take advantage of future opportunities.
Return on equity is a way to compare the business quality of different companies. Companies that can earn high returns on equity without too much debt are generally of good quality. If two companies have roughly the same level of debt and one has a higher ROE, I generally prefer the one with a higher ROE.
But when a company is of high quality, the market often gives it a price that reflects that. Earnings growth rates, relative to expectations reflected in the share price, are particularly important to consider. So I think it’s worth checking it out free analyst forecast report for the company.
Sure, you might find a fantastic investment by looking elsewhere. So take a look at this free list of interesting companies.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.
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