While some investors are already well versed in financial metrics (hat tip), this article is for those who would like to learn about Return On Equity (ROE) and why it is important. We’ll use ROE to examine Perrot Duval Holding S.A. (VTX:PEDU), by way of a worked example.
Return on equity or ROE is a key measure used to assess how efficiently a company’s management is utilizing the company’s capital. Put another way, it reveals the company’s success at turning shareholder investments into profits.
Check out our latest analysis for Perrot Duval Holding
How Do You Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders’ Equity
So, based on the above formula, the ROE for Perrot Duval Holding is:
17% = CHF1.0m ÷ CHF5.9m (Based on the trailing twelve months to October 2019).
The ‘return’ refers to a company’s earnings over the last year. That means that for every CHF1 worth of shareholders’ equity, the company generated CHF0.17 in profit.
Does Perrot Duval Holding Have A Good Return On Equity?
By comparing a company’s ROE with its industry average, we can get a quick measure of how good it is. The limitation of this approach is that some companies are quite different from others, even within the same industry classification. Pleasingly, Perrot Duval Holding has a superior ROE than the average (11%) in the Machinery industry.
That’s clearly a positive. With that said, a high ROE doesn’t always indicate high profitability. Aside from changes in net income, a high ROE can also be the outcome of high debt relative to equity, which indicates risk. To know the 3 risks we have identified for Perrot Duval Holding visit our risks dashboard for free.
The Importance Of Debt To Return On Equity
Most companies need money — from somewhere — to grow their profits. That cash can come from issuing 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 debt used for growth will improve returns, but won’t affect the total equity. That will make the ROE look better than if no debt was used.
Combining Perrot Duval Holding’s Debt And Its 17% Return On Equity
It’s worth noting the high use of debt by Perrot Duval Holding, leading to its debt to equity ratio of 1.25. There’s no doubt its ROE is decent, but the very high debt the company carries is not too exciting to see. Debt does bring extra risk, so it’s only really worthwhile when a company generates some decent returns from it.
Return on equity is one way we can compare its business quality of different companies. In our books, the highest quality companies have high return on equity, despite low debt. If two companies have around the same level of debt to equity, and one has a higher ROE, I’d generally prefer the one with higher ROE.
But when a business is high quality, the market often bids it up to a price that reflects this. The rate at which profits are likely to grow, relative to the expectations of profit growth reflected in the current price, must be considered, too. Check the past profit growth by Perrot Duval Holding by looking at this visualization of past earnings, revenue and cash flow.
But note: Perrot Duval Holding may not be the best stock to buy. So take a peek at this free list of interesting companies with high ROE and low debt.
If you spot an error that warrants correction, please contact the editor at [email protected] This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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