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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 Apollo Sindoori Hotels Limited (NSE:APOLSINHOT), by way of a worked example.
Our data shows Apollo Sindoori Hotels has a return on equity of 30% for the last year. That means that for every ₹1 worth of shareholders' equity, it generated ₹0.30 in profit.
How Do You Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit ÷ Shareholders' Equity
Or for Apollo Sindoori Hotels:
30% = ₹206m ÷ ₹675m (Based on the trailing twelve months to March 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 the capital paid in by shareholders, plus any retained earnings. Shareholders' equity can be calculated by subtracting the total liabilities of the company from the total assets of the company.
What Does ROE Mean?
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. The higher the ROE, the more profit the company is making. So, all else equal, investors should like a high ROE. Clearly, then, one can use ROE to compare different companies.
Does Apollo Sindoori Hotels Have A Good Return On Equity?
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. As you can see in the graphic below, Apollo Sindoori Hotels has a higher ROE than the average (7.1%) in the Commercial Services industry.
That's what I like to see. 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.
The Importance Of Debt To 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 use of debt will improve the returns, but will not change the equity. Thus the use of debt can improve ROE, albeit along with extra risk in the case of stormy weather, metaphorically speaking.
Apollo Sindoori Hotels's Debt And Its 30% ROE
While Apollo Sindoori Hotels does have a tiny amount of debt, with debt to equity of just 0.0013, we think the use of debt is very modest. When I see a high ROE, fuelled by only modest debt, I suspect the business is high quality. Careful use of debt to boost returns is often very good for shareholders. However, it could reduce the company's ability to take advantage of future opportunities.
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 around the same level of debt to equity, and one has a higher ROE, I'd generally prefer the one with higher ROE.
But when a business is high quality, the market often bids it up to a price that reflects this. 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 .
If you would prefer check out another company -- one with potentially superior financials -- then do not miss this free list of interesting companies, that have HIGH return on equity and low debt.
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.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Thank you for reading.