Many investors are still educating themselves about the various metrics that can be useful when analyzing a stock. This article is for those who want to learn more about return on equity (ROE). To keep the lesson grounded in practice, we’ll use ROE to better understand Huajin International Holdings Limited (HKG: 2738).
ROE or return on equity is a useful tool to assess how effectively a company can generate the returns on investment it has received from its shareholders. In simpler terms, it measures a company’s profitability relative to equity.
See our latest analysis for Huajin International Holdings
How do you calculate return on equity?
ROE can be calculated using the formula:
Return on equity = Net income (from continuing operations) ÷ Equity
Thus, based on the above formula, the ROE of Huajin International Holdings is:
18% = CN ¥ 105m CN ¥ 577m (Based on the last twelve months to June 2021).
The “return” is the income the business has earned over the past year. This means that for every HK $ 1 worth of equity, the company generated HK $ 0.18 in profit.
Does Huajin International Holdings have a good return on equity?
By comparing a company’s ROE with its industry average, we can get a quick measure of its quality. The limitation of this approach is that some companies are very different from others, even within the same industry classification. Fortunately, Huajin International Holdings has an above-average ROE (13%) for the metals and mining industry.
This is what we love to see. That said, high ROE doesn’t always indicate high profitability. Besides changes in net income, high ROE can also be the result of high leverage to equity, which indicates risk. To learn about the 4 risks we have identified for Huajin International Holdings, visit our free risk dashboard.
The importance of debt to return on equity
Businesses generally need to invest money to increase their profits. This liquidity can come from retained earnings, the issuance of new shares (shares) 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 returns, but will not affect equity. This will make the ROE better than if no debt was used.
Combine Huajin International Holdings’ debt and its 18% return on equity
Huajin International Holdings uses a large amount of debt to increase returns. Its debt ratio is 2.37. While its ROE is respectable, it should be borne in mind that there is usually a limit on how much debt a business can use. Debt comes with additional risk, so it’s only really worth it when a business is making decent returns from it.
Return on equity is a useful indicator of a company’s ability to generate profits and return them to shareholders. A business that can earn a high return on equity without going into debt could be considered a high quality business. All other things being equal, a higher ROE is preferable.
But when a company is of high quality, the market often offers it up to a price that reflects that. The rate at which earnings are likely to grow, relative to earnings growth expectations reflected in the current price, must also be considered. So I think it’s worth checking this out free this detailed graphic past profits, income and cash flow.
Sure Huajin International Holdings may not be the best stock to buy. So you might want to see this free collection of other companies with high ROE and low leverage.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in any of the stocks mentioned.
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