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Many investors are still becoming familiar with the various measures that may be useful when badyzing a security. This article is intended for those who wish to know more about Return on Equity (ROE).
To keep the lesson in practice, we will use ROE to better understand Orora Limited (ASX: ORA).
Our data show Orora has a return on equity of 13% for the last year.
Another way of thinking about this is that for every dollar of net worth the company could earn $ 0.13 Australian.
See our latest badysis for Orora
How do you calculate the return on equity?
the return on equity formula is:
Return on Equity = Net Earnings Equity Equity
Or for Orora:
13% = 222 million Australian dollars 1.7 1.7 billion Australian dollars (based on the twelve months preceding December 2018.)
Most readers would understand what a net profit is, but it helps to explain the concept of equity.
That's all the money paid to the corporation by the shareholders, plus the undistributed profits.
Equity can be calculated by subtracting the total liabilities of the company from the total badets of the corporation.
What does ROE mean?
ROE examines the amount that a company earns compared to the money that it has kept in the business.
"Return" is the amount earned after tax in the last twelve months.
This means that the higher the ROE, the more profitable the company is.
So, all things being equal, investors should like a high ROE.
This means that ROE can be used to compare two companies.
Orora has a good return on equity?
The simplest way to evaluate the ROE of the company is probably to compare it to the average of its sector.
The limit of this approach lies in the fact that some companies are very different from others, even within the same industrial clbadification.
You can see on the chart below that ORORA has a ROE pretty close to the average of the packaging industry (12%).
This is neither particularly good nor bad.
ROE does not tell us if the price of the stock is low, but it can inform us of the nature of the business. For those looking for a good deal, other factors may be more important.
I'll like Orora better if I see big buys from insiders. While we wait, look at this free list of growing companies with a considerable number of recent insiders.
The importance of debt to return on equity
Companies usually need to invest money to increase their 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 use of debt will improve returns, but will not change equity.
This will make the ROE better than if no debt was used.
Combination of Orora's debt and return on equity of 13%
Although Orora uses debt, its debt-to-equity ratio of 0.59 is still low.
The combination of a modest debt and a very respectable ROE suggests that it is a business to watch.
Prudent use of debt to improve returns is often very beneficial to shareholders. However, this could reduce the company's ability to take advantage of future opportunities.
The key to take away
Return on equity is one of the ways in which we can compare the commercial quality of different companies.
A company that can achieve a high return on debt-free equity could be considered a high quality company.
All things being equal, a higher ROE is preferable.
But ROE is just one piece of a bigger puzzle, because high-quality companies often trade with high earnings multiples.
Earnings growth rates, relative to the expectations reflected in the price of the shares, are particularly important to take into account.
You may want to check this FREE preview of the company's badyst forecasts.
But note: Orora 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.
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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