While some investors are already well versed in financial metrics (hat tip),will corn snakes eat crickets 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 TCPL Packaging Limited (
NSE:TCPLPACK
), by way of a worked example.
TCPL Packaging has a ROE of 12%
, based on the last twelve months. Another way to think of that is that for every ₹1 worth of equity in the company, it was able to earn ₹0.12.
Check out our latest analysis for TCPL Packaging
How Do I Calculate Return On Equity?
The
formula for return on equity
is:
Return on Equity = Net Profit ÷ Shareholders’ Equity
Or for TCPL Packaging:
12% = 272.299 ÷ ₹2.3b (Based on the trailing twelve months to September 2018.)
Most know that net profit is the total earnings after all expenses, but the concept of shareholders’ equity is a little more complicated. It is all earnings retained by the company, plus any capital paid in by shareholders. Shareholders’ equity can be calculated by subtracting the total liabilities of the company from the total assets of the company.
What Does ROE Signify?
Return on Equity measures a company’s profitability against the profit it has kept for the business (plus any capital injections). The ‘return’ is the profit over the last twelve months. That means that the higher the ROE, the more profitable the company is. So, as a general rule,
a high ROE is a good thing
. That means it can be interesting to compare the ROE of different companies.
Does TCPL Packaging Have A Good ROE?
One simple way to determine if a company has a good return on equity is to compare it to the average for its industry. The limitation of this approach is that some companies are quite different from others, even within the same industry classification. As you can see in the graphic below, TCPL Packaging has a higher ROE than the average (8.7%) in the Packaging industry.
NSEI:TCPLPACK Last Perf January 2nd 19
That’s clearly a positive. We think a high ROE, alone, is usually enough to justify further research into a company. One data point to check is if
insiders have bought shares recently
.
How Does Debt Impact ROE?
Virtually all companies need money to invest in the business, to grow profits. That cash can come from retained earnings, issuing 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 required for growth will boost returns, but will not impact the shareholders’ equity. That will make the ROE look better than if no debt was used.
Story continues
Combining TCPL Packaging’s Debt And Its 12% Return On Equity
TCPL Packaging does use a significant amount of debt to increase returns. It has a debt to equity ratio of 1.39. 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.
But It’s Just One Metric
Return on equity is one way we can compare the business quality of different companies. A company that can achieve a high return on equity without debt could be considered a high quality business. If two companies have the same ROE, then I would generally prefer the one with less debt.
Having said that, while ROE is a useful indicator of business quality, you’ll have to look at a whole range of factors to determine the right price to buy a stock. It is important to consider other factors, such as future profit growth — and how much investment is required going forward. So I think it may be worth checking this
free
this
detailed graph
of past earnings, revenue and cash flow
.
But note:
TCPL Packaging 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.
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
.
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