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 Abu Dhabi National Energy Company PJSC (ADX: TAQA).
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 other words, it reveals the company’s success in turning shareholders’ investments into profits.
Check out our latest analysis for Abu Dhabi National Energy Company PJSC
How to calculate return on equity?
the return on equity formula is:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the above formula, the ROE for Abu Dhabi National Energy Company PJSC is:
8.4% = د.إ 6.0 b ÷ د.إ 72 b (Based on the last twelve months up to September 2021).
The “return” is the amount earned after tax over the past twelve months. This therefore means that for each AED1 of the investments of its shareholder, the company generates a profit of AED0.08.
Does Abu Dhabi National Energy Company PJSC have 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 from the graph below that Abu Dhabi National Energy Company PJSC has an ROE quite close to the integrated utilities sector average (8.4%).
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 so, it increases their exposure to financial risk.
Why You Should Consider Debt When Looking At ROE
Businesses generally need to invest money to increase their profits. The money for the investment can come from the profits of the previous year (retained earnings), from the issuance of new shares or from loans. In the first two cases, the ROE will capture this use of capital to grow. In the latter case, the debt used for growth will improve returns, but will not affect total equity. This will make the ROE better than if no debt was used.
Abu Dhabi National Energy Company PJSC’s debt and its ROE of 8.4%
Noteworthy is the high reliance on debt by Abu Dhabi National Energy Company PJSC, resulting in a debt-to-equity ratio of 1.00. With a fairly low ROE and heavy use of debt, it’s hard to get excited about this business right now. 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 useful for comparing the quality of different companies. A business that can earn a high return on equity without going into debt can be considered a high quality business. All other things being equal, a higher ROE is preferable.
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. So I think it’s worth checking this out free analyst forecast report for the company.
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. 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 any stock 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.