One of the best investments we can make is in our own knowledge and skills. With that in mind, this article will explain how we can use return on equity (ROE) to better understand a business. We will use ROE to examine Arabian International Healthcare Holding Company (TADAWUL:9530), as a concrete example.
ROE or return on equity is a useful tool for evaluating how effectively a company can generate returns on the investment it has received from its shareholders. In simpler terms, it measures a company’s profitability relative to equity.
See our latest analysis for Arabian International Healthcare Holding
How to calculate return on equity?
The ROE formula is:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the above formula, the ROE for Arabian International Healthcare Holding is:
25% = ر.س82m ÷ ر.س333m (Based on the last twelve months to December 2021).
“Yield” refers to a company’s earnings over the past year. This therefore means that for every SAR1 of its shareholder’s investments, the company generates a profit of SAR0.25.
Does Arabian International Healthcare Holding have a good ROE?
A simple way to determine if a company has a good return on equity is to compare it to the average for its industry. The limitation of this approach is that some companies are quite different from others, even within the same industrial classification. Fortunately, Arabian International Healthcare Holding has an above average ROE (14%) for the healthcare industry.
It’s a good sign. However, keep in mind that a high ROE does not necessarily indicate efficient profit generation. A higher proportion of debt in a company’s capital structure can also result in a high ROE, where high debt levels could be a huge risk. To learn about the 3 risks we have identified for Arabian International Healthcare Holding, visit our risk dashboard for free.
Why You Should Consider Debt When Looking at ROE
Most businesses need money – from somewhere – to increase their profits. This money can come from retained earnings, issuing new stock (shares), 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, debt used for growth will enhance returns, but will not affect total equity. This will make the ROE better than if no debt was used.
Combine Arabian International Healthcare Holding’s debt with its 25% return on equity
Although Arabian International Healthcare Holding has some debt, with a debt ratio of only 0.83, we wouldn’t say the debt is excessive. The combination of modest debt and a very respectable ROE suggests that this is activity to watch. Judicious use of debt to improve returns can certainly be a good thing, even if it slightly increases risk and reduces future optionality.
Return on equity is a useful indicator of a company’s ability to generate profits and return them to shareholders. A company that can earn a high return on equity without going into debt could be considered a high quality company. All things being equal, a higher ROE is better.
But when a company is of high quality, the market often gives it a price that reflects that. The rate at which earnings are likely to grow, relative to earnings growth expectations reflected in the current price, should also be considered. So I think it’s worth checking it out free this detailed graph past profits, revenue and cash flow.
If you’d rather check out another company – one with potentially superior finances – then don’t miss this free list of attractive companies, which have a high return on equity and low debt.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.