Many investors are still educating themselves about the various metrics that can be useful when analyzing a stock. This article is for those who want to learn more about return on equity (ROE). As a learning-by-doing, we’ll take a look at the ROE to better understand the South China Vocational Education Group Company Limited (HKG: 6913).
ROE or return on equity is a useful tool to assess how effectively a company can generate the returns on investment it has received from its shareholders. Simply put, it is used to assess a company’s profitability against its equity.
Check out our latest review for South China Vocational Education Group
How do you calculate return on equity?
the formula for ROE is:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the above formula, the ROE of South China Vocational Education Group is:
19% = CN ¥ 194m CN ¥ 1.0b (Based on the last twelve months to June 2021).
The “return” is the profit of the last twelve months. Another way to look at this is that for every HK $ 1 worth of equity, the company was able to make HK $ 0.19 in profit.
Does South China Vocational Education Group Have a Good Return on Equity?
An easy way to determine if a company has a good return on equity is to compare it to the average in its industry. It is important to note that this measure is far from perfect, as companies differ considerably within a single industry classification. As you can see in the graph below, South China Vocational Education Group has an above-average ROE (9.5%) for the consumer services industry.
This is clearly a positive point. However, keep in mind that a high ROE does not necessarily indicate efficient profit generation. A higher proportion of debt in a company’s capital structure can also result in high ROE, where high debt levels could represent a huge risk.
The importance of debt to return on equity
Almost all businesses need money to invest in the business, to increase their profits. This liquidity can come from retained earnings, the issuance of new shares (equity) 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 will not affect total equity. In this way, the use of debt will increase the ROE, even if the basic economy of the business remains the same.
South China Vocational Education Group Debt and 19% ROE
The South China Vocational Education Group has a debt ratio of 0.30, which is far from excessive. The combination of modest debt and a very respectable ROE suggests that this is a business to watch. Using debt wisely to improve returns can certainly be a good thing, even if it slightly increases risk and lowers future option.
Return on equity is a useful indicator of a company’s ability to generate profits and return them to shareholders. Firms that can earn high returns on equity without taking on too much debt are generally of good quality. 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 stock price. You can see how the business has grown in the past by checking out this FREE detailed graphic past earnings, income and cash flow.
Sure, you might find a fantastic investment looking elsewhere. So take a look at this free list of interesting companies.
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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 any stock 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 documents. Simply Wall St has no position in any of the stocks mentioned.