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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). To keep the lesson grounded in practicality, we'll use ROE to better understand R.P.P. Infra Projects Limited (NSE:RPPINFRA).
R.P.P. Infra Projects has a ROE of 8.9%, based on the last twelve months. Another way to think of that is that for every ₹1 worth of equity in the company, it was able to earn ₹0.09.
See our latest analysis for R.P.P. Infra Projects
How Do I Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit ÷ Shareholders' Equity
Or for R.P.P. Infra Projects:
8.9% = ₹214m ÷ ₹2.4b (Based on the trailing twelve months to June 2019.)
Most readers would understand what net profit is, but it’s worth explaining the concept of shareholders’ equity. 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 Signify?
ROE looks at the amount a company earns relative to the money it has kept within the business. 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, all else equal, investors should like a high ROE. That means ROE can be used to compare two businesses.
Does R.P.P. Infra Projects Have A Good Return On Equity?
One simple way to determine if a company has a good return on equity is to compare it to the average for its industry. Importantly, this is far from a perfect measure, because companies differ significantly within the same industry classification. You can see in the graphic below that R.P.P. Infra Projects has an ROE that is fairly close to the average for the Construction industry (11%).
That's neither particularly good, nor bad. ROE tells us about the quality of the business, but it does not give us much of an idea if the share price is cheap. If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
How Does Debt Impact ROE?
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 and second cases, the ROE will reflect this use of cash for investment in the business. In the latter case, the debt required for growth will boost returns, but will not impact the shareholders' equity. Thus the use of debt can improve ROE, albeit along with extra risk in the case of stormy weather, metaphorically speaking.