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). We'll use ROE to examine Aspial Lifestyle Limited (Catalist:5UF), 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 Aspial Lifestyle
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Aspial Lifestyle is:
9.8% = S$17m ÷ S$168m (Based on the trailing twelve months to June 2023).
The 'return' is the income the business earned over the last year. That means that for every SGD1 worth of shareholders' equity, the company generated SGD0.10 in profit.
Does Aspial Lifestyle Have A Good ROE?
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. The image below shows that Aspial Lifestyle has an ROE that is roughly in line with the Specialty Retail industry average (9.2%).
That's neither particularly good, nor bad. Even if the ROE is respectable when compared to the industry, its worth checking if the firm's ROE is being aided by high debt levels. If a company takes on too much debt, it is at higher risk of defaulting on interest payments. Our risks dashboardshould have the 4 risks we have identified for Aspial Lifestyle.
The Importance Of Debt To Return On Equity
Virtually all companies need money to invest in the business, to grow profits. The cash for investment can come from prior year profits (retained earnings), issuing new shares, or 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 required for growth will boost returns, but will not impact the shareholders' equity. That will make the ROE look better than if no debt was used.
Combining Aspial Lifestyle's Debt And Its 9.8% Return On Equity
It appears that Aspial Lifestyle makes extensive use of debt to improve its returns, because it has an alarmingly high debt to equity ratio of 3.25. We consider it to be a negative sign when a company has a rather low ROE despite a rather high debt to equity.