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 will look at the ROE to better understand Volue ASA (OB: VOLUE).
Return on equity or ROE is an important factor for a shareholder to consider because it tells them how effectively their capital is being reinvested. In short, the ROE shows the profit that each dollar generates compared to the investments of its shareholders.
Check out our latest analysis for Volume
How to calculate return on equity?
The return on equity formula is:
Return on equity = Net income (from continuing operations) Ã· Equity
So, based on the above formula, the ROE for Volume is:
3.9% = 29m kr Ã· 743m kr (based on the last twelve months up to June 2021).
“Return” refers to a company’s profits over the past year. Another way to look at this is that for every NOK1 value of equity, the company was able to make NOK0.04 in profit.
Does volume 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. It is important to note that this measure is far from perfect, as companies differ considerably within a single industry classification. You can see from the graph below that Volue has a ROE fairly close to the Software industry average (4.3%).
It’s no wonder, but it’s respectable. Even though the ROE is respectable compared to the industry, it is worth checking out if the company’s ROE is helped by high debt levels. If so, it increases their exposure to financial risk.
The importance of debt to 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 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.
Volue’s debt and its ROE of 3.9%
Volume has a debt ratio of only 0.009, which is very low. Although the ROE is not very impressive, the leverage is modest, which suggests that the company has potential. The 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 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.
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 share price. You might want to take a look at this data-rich interactive chart of the forecast for the business.
But beware : Volume may not be the best stock to buy. So take a look at this free list of interesting companies with high ROE and low debt.
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 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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