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One of the best investments we can make is in our own knowledge and skills. With that in mind, this article will discuss how we can use Return on Equity (ROE) to better understand a business. To keep the lesson grounded in practice, we will use the ROE to better understand Minerva SA (BVMF: BEEF3).
Return on equity or ROE is a key metric used to assess the efficiency with which the management of a business is using business capital. In other words, it reveals the company’s success in turning shareholders’ investments into profits.
Check out our latest analysis for Minerva
How do you calculate return on equity?
Return on equity can be calculated using the formula:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the above formula, Minerva’s ROE is:
68% = 685 million reais ÷ 1.0 billion reais (based on the last twelve months up to March 2021).
The “return” is the income the business has earned over the past year. This therefore means that for every R $ 1 of the investments of its shareholder, the company generates a profit of R $ 0.68.
Does Minerva have a good return on equity?
Perhaps the easiest way to assess a company’s ROE is to compare it to the industry average. However, this method is only useful as a rough check, as companies differ a lot within a single industry classification. As you can see in the graph below, Minerva has an above-average ROE (19%) for the food industry.
It’s a good sign. 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. To learn about the 4 risks we have identified for Minerva, visit our free risk dashboard.
What is the impact of debt on ROE?
Most businesses need money – from somewhere – to increase their profits. The money for the investment can come from the profits of the previous year (retained earnings), from the issuance of new shares or from loans. 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 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.
Combine Minerva’s Debt and Its 68% Return on Equity
It looks like Minerva is using a huge volume of debt to fund the business, as she has an extremely high debt ratio of 11.63. While his ROE is undoubtedly quite impressive, he could give the wrong impression on the company’s returns given that his huge debt could increase those returns.
summary
Return on equity is a way to compare the business quality of different companies. Firms that can earn high returns on equity without taking on too much debt are generally of good quality. All other things being equal, a higher ROE is preferable.
But ROE is only one piece of a bigger puzzle, as high-quality companies often trade at high earnings multiples. Especially important to consider are the growth rates of earnings, relative to expectations reflected in the share price. You might want to take a look at this data-rich interactive chart of the forecast for the business.
Of course, you might find a fantastic investment looking elsewhere. So take a look at this free list of interesting companies.
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This Simply Wall St article is general in nature. 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 documents. Simply Wall St has no position in any of the stocks mentioned.
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