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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 HOCHTIEF Aktiengesellschaft (ETR:HOT).
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
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 HOCHTIEF is:
73% = €867m ÷ €1.2b (Based on the trailing twelve months to December 2024).
The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each €1 of shareholders' capital it has, the company made €0.73 in profit.
View our latest analysis for HOCHTIEF
Does HOCHTIEF 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. However, this method is only useful as a rough check, because companies do differ quite a bit within the same industry classification. As is clear from the image below, HOCHTIEF has a better ROE than the average (13%) in the Construction industry.
That is a good sign. 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. To know the 3 risks we have identified for HOCHTIEF visit our risks dashboard for free.
The Importance Of Debt To Return On Equity
Virtually all companies need money to invest in the business, to grow profits. That cash can come from retained earnings, issuing new shares (equity), or debt. 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. Thus the use of debt can improve ROE, albeit along with extra risk in the case of stormy weather, metaphorically speaking.
Combining HOCHTIEF's Debt And Its 73% Return On Equity
It seems that HOCHTIEF uses a huge volume of debt to fund the business, since it has an extremely high debt to equity ratio of 6.21. Its ROE is clearly quite good, but it seems to be boosted by the significant use of debt by the company.