U.S. Markets closed

How Did Pelatro Plc’s (LON:PTRO) 16% ROE Fare Against The Industry?

Jacob Boyd

Many investors are still learning about the various metrics that can be useful when analysing a stock. This article is for those who would like to learn about Return On Equity (ROE). We’ll use ROE to examine Pelatro Plc (LON:PTRO), by way of a worked example.

Over the last twelve months Pelatro has recorded a ROE of 16%. Another way to think of that is that for every £1 worth of equity in the company, it was able to earn £0.16.

Check out our latest analysis for Pelatro

Want to help shape the future of investing tools and platforms? Take the survey and be part of one of the most advanced studies of stock market investors to date.

How Do I Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit ÷ Shareholders’ Equity

Or for Pelatro:

16% = 1.069 ÷ US$7.0m (Based on the trailing twelve months to June 2018.)

Most readers would understand what net profit is, but it’s worth explaining the concept of shareholders’ equity. It is all earnings retained by the company, plus any capital paid in by shareholders. The easiest way to calculate shareholders’ equity is to subtract the company’s total liabilities from the total assets.

What Does ROE Signify?

ROE looks at the amount a company earns relative to the money it has kept within the business. The ‘return’ is the profit over the last twelve months. A higher profit will lead to a higher ROE. So, all else being equal, a high ROE is better than a low one. That means ROE can be used to compare two businesses.

Does Pelatro 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 Pelatro has an ROE that is roughly in line with the Software industry average (16%).

AIM:PTRO Last Perf January 22nd 19

That isn’t amazing, but it is respectable. ROE doesn’t tell us if the share price is low, but it can inform us to the nature of the business. For those looking for a bargain, other factors may be more important. I will like Pelatro better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

How Does Debt Impact Return On Equity?

Most companies need money — from somewhere — to grow their profits. The cash for investment can come from prior year profits (retained earnings), issuing new shares, or borrowing. 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 won’t affect the total equity. That will make the ROE look better than if no debt was used.

Combining Pelatro’s Debt And Its 16% Return On Equity

Although Pelatro does use a little debt, its debt to equity ratio of just 0.07 is very low. Its very respectable ROE, combined with only modest debt, suggests the business is in good shape. Judicious use of debt to improve returns can certainly be a good thing, although it does elevate risk slightly and reduce future optionality.

But It’s Just One Metric

Return on equity is one way we can compare the business quality of different companies. 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 ROE is just one piece of a bigger puzzle, since high quality businesses often trade on high multiples of earnings. It is important to consider other factors, such as future profit growth — and how much investment is required going forward. So you might want to take a peek at this data-rich interactive graph of forecasts for the company.

Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of interesting companies.

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 editorial-team@simplywallst.com.