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. By way of learning-by-doing, we’ll look at ROE to gain a better understanding of CEDAR.Co.,Ltd. (TYO:2435).
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.
Check out our latest analysis for CEDAR.Co.Ltd
How Do You Calculate Return On Equity?
Return on equity can be calculated by using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders’ Equity
So, based on the above formula, the ROE for CEDAR.Co.Ltd is:
36% = JP¥550m ÷ JP¥1.5b (Based on the trailing twelve months to September 2020).
The ‘return’ is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each ¥1 of shareholders’ capital it has, the company made ¥0.36 in profit.
Does CEDAR.Co.Ltd Have A Good Return On Equity?
One simple way to determine if a company has a good return on equity is to compare it to the average for its industry. However, this method is only useful as a rough check, because companies do differ quite a bit within the same industry classification. Pleasingly, CEDAR.Co.Ltd has a superior ROE than the average (9.2%) in the Healthcare industry.
That is a good sign. With that said, a high ROE doesn’t always indicate high profitability. Especially when a firm uses high levels of debt to finance its debt which may boost its ROE but the high leverage puts the company at risk. To know the 4 risks we have identified for CEDAR.Co.Ltd visit our risks dashboard for free.
How Does Debt Impact Return On Equity?
Companies usually need to invest money to grow their profits. That cash can come from issuing shares, retained earnings, 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 used for growth will improve returns, but won’t affect the total equity. In this manner the use of debt will boost ROE, even though the core economics of the business stay the same.
CEDAR.Co.Ltd’s Debt And Its 36% ROE
It seems that CEDAR.Co.Ltd uses a huge volume of debt to fund the business, since it has an extremely high debt to equity ratio of 5.42. While its ROE is no doubt quite impressive, it could give a false impression about the company’s returns given that its huge debt could be boosting those returns.
Conclusion
Return on equity is useful for comparing the quality of different businesses. A company that can achieve a high return on…
Read More: Why CEDAR.Co.,Ltd. (TYO:2435) Looks Like A Quality Company