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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. To keep the lesson grounded in practicality, we’ll use ROE to better understand Xiabuxiabu Catering Management (China) Holdings Co Ltd (HKG:520).
Our data shows Xiabuxiabu Catering Management (China) Holdings has a return on equity of 21% for the last year. One way to conceptualize this, is that for each HK$1 of shareholders’ equity it has, the company made HK$0.21 in profit.
Check out our latest analysis for Xiabuxiabu Catering Management (China) Holdings
How Do You Calculate ROE?
The formula for ROE is:
Return on Equity = Net Profit ÷ Shareholders’ Equity
Or for Xiabuxiabu Catering Management (China) Holdings:
21% = CN¥441m ÷ CN¥2.1b (Based on the trailing twelve months to June 2018.)
Most readers would understand what net profit is, but it’s worth explaining the concept of shareholders’ equity. It is all the money paid into the company from shareholders, plus any earnings retained. Shareholders’ equity can be calculated by subtracting the total liabilities of the company from the total assets of the company.
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, as a general rule, a high ROE is a good thing. Clearly, then, one can use ROE to compare different companies.
Does Xiabuxiabu Catering Management (China) Holdings Have A Good ROE?
By comparing a company’s ROE with its industry average, we can get a quick measure of how good it is. Importantly, this is far from a perfect measure, because companies differ significantly within the same industry classification. As you can see in the graphic below, Xiabuxiabu Catering Management (China) Holdings has a higher ROE than the average (7.2%) in the hospitality industry.
That is a good sign. In my book, a high ROE almost always warrants a closer look. For example you might check if insiders are buying shares.
Why You Should Consider Debt When Looking At ROE
Virtually all companies need money to invest in the business, to grow profits. That cash can come from issuing shares, retained earnings, or debt. In the first and second cases, the ROE will reflect this use of cash for investment in the business. 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.