Many investors are still educating themselves about the various metrics that can be useful when analyzing a stock. This article is for those who want to learn more about return on equity (ROE). To keep the lesson grounded in practice, we will use ROE to better understand Planet B2B SA (WSE: P2B).
Return on equity or ROE is an important factor for a shareholder to consider because it tells them how efficiently their capital is being reinvested. In short, the ROE shows the profit that each dollar generates compared to the investments of its shareholders.
Check out our latest review for Planet B2B
How is the ROE calculated?
The return on equity formula is:
Return on equity = Net income (from continuing operations) ÷ Equity
Thus, based on the above formula, the ROE of Planet B2B is:
37% = zł115k ÷ zł307k (Based on the last twelve months up to September 2020).
The “return” is the amount earned after tax over the past twelve months. This therefore means that for each PLN1 of the investments of its shareholder, the company generates a profit of PLN0.37.
Does Planet B2B have a good ROE?
By comparing a company’s ROE with its industry average, we can get a quick measure of its quality. However, this method is only useful as a rough check, as companies differ a little within the same industry classification. As you can see in the graph below, Planet B2B has an above-average ROE (17%) for the IT industry.
This is clearly a positive point. Keep in mind that a high ROE doesn’t always mean superior financial performance. A higher proportion of debt in a company’s capital structure can also result in high ROE, where high debt levels could represent a huge risk. You can see the 3 risks we have identified for Planet B2B by visiting our risk dashboard for free on our platform here.
What is the impact of debt on ROE?
Most businesses need money – from somewhere – to increase their profits. This liquidity can come from the issuance of shares, retained earnings or debt. In the first and second cases, the ROE will reflect this use of cash for investing in the business. In the latter case, the debt necessary for growth will increase returns, but will have no impact on equity. This will make the ROE better than if no debt was used.
Planet B2B’s debt and its ROE of 37%
While Planet B2B has minuscule debt, with a debt-to-equity ratio of just 0.017, we believe the use of debt is very modest. Its ROE is very impressive, and given its modest debt, this suggests that the business is of high quality. The prudent use of debt to increase returns is often very good for shareholders. However, this could reduce the company’s ability to take advantage of future opportunities.
Return on equity is useful for comparing the quality of different companies. In our books, the highest quality companies have a high return on equity, despite low leverage. If two companies have roughly the same level of debt to equity and one has a higher ROE, I would generally prefer the one with a higher ROE.
That said, while ROE is a useful indicator of how good a business is, you’ll need to look at a whole range of factors to determine the right price to buy a stock. The rate at which earnings are likely to grow, relative to earnings growth expectations reflected in the current price, should also be considered. You can see how the business has grown in the past by checking out this FREE detailed graphic past earnings, income and cash flow.
Sure Planet B2B may not be the best stock to buy. So you might want to see this free collection of other companies with high ROE and low leverage.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in the mentioned stocks.
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