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Is ProSiebenSat.1 Media SE's (ETR:PSM) 18% ROE Strong Compared To Its Industry?

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While some investors are already well versed in financial metrics (hat tip), 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 ProSiebenSat.1 Media SE (ETR:PSM), by way of a worked example.

ProSiebenSat.1 Media has a ROE of 18%, based on the last twelve months. That means that for every €1 worth of shareholders' equity, it generated €0.18 in profit.

View our latest analysis for ProSiebenSat.1 Media

How Do I Calculate Return On Equity?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

Or for ProSiebenSat.1 Media:

18% = €214m ÷ €1.2b (Based on the trailing twelve months to September 2019.)

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. The easiest way to calculate shareholders' equity is to subtract the company's total liabilities from the total assets.

What Does Return On Equity 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 amount earned after tax over the last twelve months. That means that the higher the ROE, the more profitable the company is. 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 ProSiebenSat.1 Media 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. Importantly, this is far from a perfect measure, because companies differ significantly within the same industry classification. The image below shows that ProSiebenSat.1 Media has an ROE that is roughly in line with the Media industry average (18%).

XTRA:PSM Past Revenue and Net Income, December 23rd 2019
XTRA:PSM Past Revenue and Net Income, December 23rd 2019

That's not overly surprising. ROE tells us about the quality of the business, but it does not give us much of an idea if the share price is cheap. I will like ProSiebenSat.1 Media 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 case of the first and second options, the ROE will reflect this use of cash, for growth. In the latter case, the use of debt will improve the returns, but will not change the equity. That will make the ROE look better than if no debt was used.

ProSiebenSat.1 Media's Debt And Its 18% ROE

ProSiebenSat.1 Media does use a significant amount of debt to increase returns. It has a debt to equity ratio of 2.61. while its ROE is respectable, it is worth keeping in mind that there is usually a limit to how much debt a company can use. Debt increases risk and reduces options for the company in the future, so you generally want to see some good returns from using it.

In Summary

Return on equity is a useful indicator of the ability of a business to generate profits and return them to shareholders. In my book the highest quality companies have high return on equity, despite low debt. 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 I think it may be worth checking this free report on analyst forecasts for the company.

But note: ProSiebenSat.1 Media 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.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.