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 Vestland Berhad (KLSE:VLB), by way of a worked example.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
View our latest analysis for Vestland Berhad
How Is ROE Calculated?
Return on equity can be calculated by using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Vestland Berhad is:
18% = RM28m ÷ RM153m (Based on the trailing twelve months to December 2023).
The 'return' is the profit over the last twelve months. Another way to think of that is that for every MYR1 worth of equity, the company was able to earn MYR0.18 in profit.
Does Vestland Berhad 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. The limitation of this approach is that some companies are quite different from others, even within the same industry classification. As is clear from the image below, Vestland Berhad has a better ROE than the average (6.8%) in the Construction industry.
That's what we like to see. However, bear in mind that a high ROE doesn’t necessarily indicate efficient profit generation. Aside from changes in net income, a high ROE can also be the outcome of high debt relative to equity, which indicates risk. You can see the 3 risks we have identified for Vestland Berhad by visiting our risks dashboard for free on our platform here.
The Importance Of Debt To Return On Equity
Most companies need money -- from somewhere -- to grow their profits. The cash for investment can come from prior year profits (retained earnings), issuing new shares, or borrowing. In the first two cases, the ROE will capture this use of capital to grow. In the latter case, the debt used for growth will improve returns, but won't affect the total equity. That will make the ROE look better than if no debt was used.
Vestland Berhad's Debt And Its 18% ROE
It's worth noting the high use of debt by Vestland Berhad, leading to its debt to equity ratio of 1.09. While its ROE is pretty respectable, the amount of debt the company is carrying currently is not ideal. Debt does bring extra risk, so it's only really worthwhile when a company generates some decent returns from it.