While some investors are already familiar with financial metrics (hat trick), this article is for those who want to learn more about return on equity (ROE) and why it matters. Learning by doing, we will look at ROE to better understand Crayon Group Holding ASA (OB:CRAYN).

Return on equity or ROE is an important factor for a shareholder to consider as it tells them how much of their capital is being reinvested. In other words, it reveals the company’s success in turning shareholders’ investments into profits.

Discover our latest analysis for Crayon Group Holding

How is ROE calculated?

the ROE formula is:

Return on equity = Net income (from continuing operations) ÷ Equity

So, based on the formula above, the ROE of Crayon Group Holding is:

11% = 135 million kr ÷ 1.2 billion kr (based on the last twelve months until September 2021).

“Yield” is the income the business has earned over the past year. Thus, this means that for every NOK1 of its shareholder’s investment, the company generates a profit of NOK0.11.

Does Crayon Group Holding have a good ROE?

Perhaps the easiest way to assess a company’s ROE is to compare it to the industry average. The limitation of this approach is that some companies are very different from others, even within the same industrial classification. As the image below clearly shows, Crayon Group Holding has a better ROE than the software industry average (4.7%).

OB:CRAYN Return on Equity February 9, 2022

This is clearly a positive point. However, keep in mind that a high ROE does not necessarily indicate efficient profit generation. A higher proportion of debt in a company’s capital structure can also result in a high ROE, where high debt levels could be a huge risk.

What is the impact of debt on ROE?

Most businesses need money – from somewhere – to increase their profits. The money for the investment can come from the previous year’s earnings (retained earnings), from issuing new shares or from borrowing. In the case of the first and second options, the ROE will reflect this use of cash, for growth. In the latter case, the debt necessary for growth will boost returns, but will not impact equity. In this way, the use of debt will increase ROE, even though the core economics of the business remains the same.

Combine Crayon Group Holding’s debt and 11% return on equity

Crayon Group Holding is clearly using a high amount of debt to boost returns, as it has a leverage ratio of 1.75. With a fairly low ROE and a significant reliance on debt, it is difficult to get enthusiastic about this activity at the moment. Debt increases risk and reduces options for the business in the future, so you generally want to see good returns using it.

Summary

Return on equity is a useful indicator of a company’s ability to generate profits and return them to shareholders. A company that can earn a high return on equity without going into debt could be considered a high quality company. If two companies have roughly the same level of debt and one has a higher ROE, I generally prefer the one with a higher ROE.

But ROE is only one piece of a larger puzzle, as high-quality companies often trade on high earnings multiples. The rate at which earnings are likely to grow, relative to earnings growth expectations reflected in the current price, should also be considered. You might want to take a look at this data-rich interactive chart of the company’s forecast.

But note: Crayon Group Holding may not be the best stock to buy. So take a look at this free list of interesting companies with high ROE and low debt.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.