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One of the best investments we can make is in our own knowledge and skills. Keeping this in mind, this article explains how we can use ROE (Return On Equity) to better understand a business.
To keep the lesson practical, we will use ROE to better understand DuluxGroup Limited (ASX: DLX).
DuluxGroup has a ROE of 34%, based on the last twelve months.
Another way of thinking about this is that for every dollar in the company's net worth, the company could earn $ 0.34.
See our latest badysis for DuluxGroup
How do you calculate the return on equity?
the formula for ROE is:
Return on Equity = Net Earnings Equity Equity
Or for DuluxGroup:
34% = 151 million Australian dollars 440 440 million Australian dollars (based on the twelve months preceding September 2018.)
Most know that net income is the total profit after all expenses, but the concept of equity is a bit more complicated.
That's all the money paid to the corporation by the shareholders, plus the undistributed profits.
The simplest way to calculate equity is to subtract the total liabilities of the company from the total badets.
What does the return on equity mean?
Return on equity measures the profitability of a business relative to the profits it has made for the business (plus any capital injection).
"Return" is the amount earned after tax in the last twelve months.
A higher profit will lead to a higher ROE.
So, as a rule, a high ROE is a good thing.
This means that it can be interesting to compare the ROE of different companies.
Does DuluxGroup have a good return on equity?
A simple way to determine whether a company is generating a good return on equity is to compare it to the average of its sector.
It is important to note that this is far from being a perfect measure, as companies differ considerably within the same industrial clbadification.
DuluxGroup has a higher than average return on investment (26%) in the chemicals sector.
This is a good sign.
I usually take a closer look at when a company has a better ROE than its peers in the industry.
For example, I often check whether insiders have bought shares .
How does debt affect ROE?
Virtually every business needs money to invest in the business and increase profits.
This money can come from retained earnings, issuance of new shares (equity) or debt.
In the case of the first and second options, the ROE will reflect this cash utilization for growth.
In the latter case, the debt required for growth will boost returns, but will have no impact on equity.
Thus, recourse to debt can improve the ROE, but with additional risk in the event of a storm, in metaphorical terms.
DuluxGroup's debt and ROE at 34%
DuluxGroup uses a large debt to increase returns. Its debt ratio is 1.01.
Although the ROE is impressive, this measure has clearly benefited from the company's use of the debt.
Investors need to think carefully about how a company could behave if it were unable to borrow so easily, as credit markets evolve over time.
The final result on ROE
Return on equity is useful for comparing the quality of different companies.
A company that can achieve a high return on debt-free equity could be considered a high quality company.
All other things being equal, a higher ROE is preferable.
But when a company is of high quality, the market often offers it a price that takes it into account.
The probable rate of profit growth relative to the earnings growth forecast reflected in the current price must also be taken into account.
So I think it's worth checking that free report on badysts' forecasts for the company.
If you prefer to consult another company – a company with potentially higher finances – then do not miss this opportunity. free list of interesting companies, which have a high return on equity and a low debt.
Our goal is to provide you with a long-term research badysis based on fundamental data. Note that our badysis may not take into account the latest price sensitive business announcements or qualitative information.
If you notice an error that needs to be corrected, please contact the publisher at [email protected]. This article from Simply Wall St is of a general nature. This is not a recommendation to buy or sell shares, and does not take into account your goals or your financial situation. Simply Wall St has no position on the actions mentioned. Thanks for the reading.
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