While some investors are already familiar with financial metrics (hat tip), this article is for those who want to learn more about return on equity (ROE) and why it is important. As a learning-by-doing, we’ll take a look at the ROE to better understand Ubisoft Entertainment SA (EPA: UBI).
Return on equity or ROE is a key metric used to assess the efficiency with which the management of a business is using business capital. In simpler terms, it measures a company’s profitability relative to equity.
Check out our latest analysis for Ubisoft Entertainment
How do you calculate return on equity?
ROE can be calculated using the formula:
Return on equity = Net income (from continuing operations) ÷ Equity
Thus, based on the above formula, Ubisoft Entertainment’s ROE is:
6.3% = 105 million euros ÷ 1.7 billion euros (based on the last twelve months up to March 2021).
The “return” is the profit of the last twelve months. This therefore means that for 1 € of investment by its shareholder, the company generates a profit of 0.06 €.
Does Ubisoft Entertainment 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 in its industry. The limitation of this approach is that some companies are very different from others, even within the same industry classification. If you look at the image below, you can see that Ubisoft Entertainment has a ROE similar to the Entertainment Industry Rating Average (6.0%).
It’s no wonder, but it’s respectable. While at least the ROE is not lower than that of the industry, it is still worth checking out the role that corporate debt plays, as high levels of debt relative to equity can also make the ROE appear high. If this is true, it is more an indication of risk than potential. Our risk dashboard should include the 2 risks that we have identified for Ubisoft Entertainment.
What is the impact of debt on return on equity?
Most businesses need money – from somewhere – to increase their profits. This liquidity can come from the issuance of shares, retained earnings or debt. In the first and second cases, the ROE will reflect this use of cash for investment in the business. In the latter case, the debt necessary for growth will increase returns, but will have no impact on equity. So, using debt can improve ROE, but with added risk in stormy weather, metaphorically speaking.
Ubisoft Entertainment’s debt and its ROE of 6.3%
Ubisoft Entertainment uses a large amount of debt to increase returns. Its debt ratio is 1.05. Its ROE is quite low, even with significant recourse to debt; this is not a good result, in our opinion. Debt brings additional risk, so it’s only really worth it when a business is making decent returns from it.
Return on equity is a useful indicator of a company’s ability to generate profits and return them to shareholders. Firms that can earn high returns on equity without taking on too much debt are generally of good quality. All other things being equal, a higher ROE is preferable.
But when a company is of high quality, the market often offers it up to a price that reflects that. The rate at which earnings are likely to grow, relative to earnings growth expectations reflected in the current price, should also be considered. You might want to take a look at this data-rich interactive chart of the forecast for the business.
Of course, you might find a fantastic investment looking elsewhere. So take a look at this free list of interesting companies.
If you decide to trade Ubisoft Entertainment, use the cheapest platform * which is ranked # 1 overall by Barron’s, Interactive brokers. Trade stocks, options, futures, currencies, bonds and funds in 135 markets, all from one integrated account.
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 the mentioned stocks.
*Interactive Brokers Ranked Least Expensive Broker By StockBrokers.com Online Annual Review 2020
Do you have any feedback on this item? Are you worried about the content? Get in touch with us directly. You can also send an email to the editorial team (at) simplywallst.com.