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 Sucro Limited (CVE:SUGR), by way of a worked example.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Sucro

How Is ROE Calculated?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Sucro is:

9.1% = US$15m ÷ US$169m (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. That means that for every CA$1 worth of shareholders' equity, the company generated CA$0.09 in profit.

Does Sucro Have A Good ROE?

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. If you look at the image below, you can see Sucro has a lower ROE than the average (14%) in the Consumer Retailing industry classification.

That's not what we like to see. However, a low ROE is not always bad. If the company's debt levels are moderate to low, then there's still a chance that returns can be improved via the use of financial leverage. A company with high debt levels and low ROE is a combination we like to avoid given the risk involved. To know the 2 risks we have identified for Sucro visit our risks dashboard for free.

The Importance Of Debt To Return On Equity

Companies usually need to invest money to grow their profits. The cash for investment can come from prior year profits (retained earnings), issuing new shares, or borrowing. 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 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.

Combining Sucro's Debt And Its 9.1% Return On Equity

Sucro clearly uses a high amount of debt to boost returns, as it has a debt to equity ratio of 1.50. Its ROE is quite low, even with the use of significant debt; that's not a good result, in our opinion. Investors should think carefully about how a company might perform if it was unable to borrow so easily, because credit markets do change over time.