Many investors are still learning the different 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 SEA Holdings Limited (HKG: 251).
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 short, the ROE shows the profit that each dollar generates compared to the investments of its shareholders.
See our latest analysis for SEA Holdings
How to 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 SEA Holdings is:
2.4% = HK $ 151 million ÷ HK $ 6.2 billion (based on the last twelve months up to December 2020).
The “return” is the profit of the last twelve months. This means that for every HK $ 1 worth of equity, the company generated HK $ 0.02 in profit.
Does SEA Holdings have a good return on equity?
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. If you look at the image below, you can see that SEA Holdings has a lower than average ROE (8.3%) for the real estate industry classification.
Unfortunately, this is suboptimal. That being said, a low ROE isn’t always a bad thing, especially if the business has low leverage as it still leaves room for improvement if the business were to take on more debt. When a company has a low ROE but high levels of debt, we would be careful because the risk involved is too high. To find out about the 2 risks that we have identified for SEA Holdings, visit our risk dashboard free of charge.
What is the impact of debt on ROE?
Businesses generally need to invest money 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 investing 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.
SEA Holdings’ debt and its ROE of 2.4%
SEA Holdings uses a large amount of debt to increase returns. It has a debt ratio of 1.65. With a fairly low ROE and heavy use of debt, it’s hard to get excited about this business right now. Debt brings additional risk, so it’s only really worth it when a business is making decent returns from it.
Return on equity is one way to compare the business quality of different companies. Firms that can earn high returns on equity without taking on too much debt are generally of good quality. 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. Especially important to consider are the growth rates of earnings, relative to expectations reflected in the stock price. You can see how the business has grown in the past by checking out this FREE detailed graphic past earnings, income and cash flow.
Of course SEA Holdings may not be the best stock to buy. So you might want to see this free collection of other companies with high ROE 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 documents. Simply Wall St has no position in any of the stocks mentioned.
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