While some investors are already well versed in financial metrics (hat tip),api 5500 numbers have come off this article is for those who would like to learn about Return On Equity (ROE) and why it is important. To keep the lesson grounded in practicality, we’ll use ROE to better understand Steel Strips Wheels Limited (

NSE:SSWL

).

Our data shows

Steel Strips Wheels has a return on equity of 13%

for the last year. Another way to think of that is that for every ₹1 worth of equity in the company, it was able to earn ₹0.13.

View our latest analysis for Steel Strips Wheels

How Do I Calculate Return On Equity?

The

formula for ROE

is:

Return on Equity = Net Profit ÷ Shareholders’ Equity

Or for Steel Strips Wheels:

13% = 833.189 ÷ ₹6.5b (Based on the trailing twelve months to September 2018.)

It’s easy to understand the ‘net profit’ part of that equation, but ‘shareholders’ equity’ requires further explanation. It is all the money paid into the company from shareholders, plus any earnings retained. The easiest way to calculate shareholders’ equity is to subtract the company’s total liabilities from the total assets.

What Does Return On Equity Mean?

ROE measures a company’s profitability against the profit it retains, and any outside investments. The ‘return’ is the amount earned after tax over the last twelve months. The higher the ROE, the more profit the company is making. So, all else equal,

investors should like a high ROE

. That means it can be interesting to compare the ROE of different companies.

Does Steel Strips Wheels Have A Good ROE?

Arguably the easiest way to assess company’s ROE is to compare it with the average in its industry. However, this method is only useful as a rough check, because companies do differ quite a bit within the same industry classification. The image below shows that Steel Strips Wheels has an ROE that is roughly in line with the Auto Components industry average (14%).

NSEI:SSWL Last Perf January 2nd 19

That’s not overly surprising. ROE tells us about the quality of the business, but it does not give us much of an idea if the share price is cheap. For those who like to find

winning investments

this

free

list of growing companies with recent insider purchasing, could be just the ticket.

How Does Debt Impact ROE?

Most companies need money — from somewhere — to grow their profits. That cash can come from retained earnings, issuing new shares (equity), 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 required for growth will boost returns, but will not impact the shareholders’ equity. In this manner the use of debt will boost ROE, even though the core economics of the business stay the same.

Story continues

Combining Steel Strips Wheels’s Debt And Its 13% Return On Equity

It’s worth noting the significant use of debt by Steel Strips Wheels, leading to its debt to equity ratio of 1.31. The company doesn’t have a bad ROE, but it is less than ideal tht it has had to use debt to achieve its returns. Debt increases risk and reduces options for the company in the future, so you generally want to see some good returns from using it.

The Bottom Line On ROE

Return on equity is a useful indicator of the ability of a business to generate profits and return them to shareholders. In my book 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. Profit growth rates, versus the expectations reflected in the price of the stock, are a particularly important to consider. So you might want to check this FREE

visualization of analyst forecasts for the company

.

If you would prefer check out another company — one with potentially superior financials — then do not miss this

free

list of interesting companies, that have HIGH return on equity and low debt.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at

[email protected]

.

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