One of the best investments we can make is in our own knowledge and skill set. With that in mind, this article will work through how we can use Return On Equity (ROE) to better understand a business. By way of learning-by-doing, we’ll look at ROE to gain a better understanding of Qiwi plc (NASDAQ:QIWI).
Our data shows Qiwi has a return on equity of 13% for the last year. One way to conceptualize this, is that for each $1 of shareholders’ equity it has, the company made $0.13 in profit.
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How Do I Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit ÷ Shareholders’ Equity
Or for Qiwi:
13% = 3147 ÷ RUруб25b (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 the money paid into the company from shareholders, plus any earnings retained. You can calculate shareholders’ equity by subtracting the company’s total liabilities from its total assets.
What Does ROE Mean?
ROE measures a company’s profitability against the profit it retains, and any outside investments. The ‘return’ is the amount earned after tax over the last twelve months. A higher profit will lead to a higher ROE. So, all else equal, investors should like a high ROE. Clearly, then, one can use ROE to compare different companies.
Does Qiwi Have A Good Return On Equity?
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. If you look at the image below, you can see Qiwi has a similar ROE to the average in the IT industry classification (15%).
That’s not overly surprising. ROE can give us a view about company quality, but many investors also look to other factors, such as whether there are insiders buying shares. I will like Qiwi 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?
Companies usually need to invest money to grow their 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. In this manner the use of debt will boost ROE, even though the core economics of the business stay the same.
Combining Qiwi’s Debt And Its 13% Return On Equity
Qiwi is free of net debt, which is a positive for shareholders. Its respectable ROE suggests it is a business worth watching, but it’s even better the company achieved this without leverage. After all, when a company has a strong balance sheet, it can often find ways to invest in growth, even if it takes some time.
The Bottom Line On ROE
Return on equity is a useful indicator of the ability of a business to generate profits and return them to shareholders. A company that can achieve a high return on equity without debt could be considered a high quality business. All else being equal, a higher ROE is better.
But when a business is high quality, the market often bids it up to a price that reflects this. The rate at which profits are likely to grow, relative to the expectations of profit growth reflected in the current price, must be considered, too. So you might want to take a peek at this data-rich interactive graph of forecasts for the company.
Of course Qiwi may not be the best stock to buy. So you may wish to see this free collection of other companies that have 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 email@example.com.