Many investors are still learning the different metrics that can be useful when analyzing a stock. This article is for those who want to know more about return on equity (ROE). Learning by doing, we will look at ROE to better understand Cool Caps Industries Limited (NSE: COOLCAPS).
Return on equity or ROE is an important factor for a shareholder to consider as it tells them how much of their capital is being reinvested. In simple terms, it is used to assess the profitability of a company in relation to its equity.
Check out our latest analysis for Cool Caps Industries
How is ROE calculated?
ROE can be calculated using the formula:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the formula above, the ROE for Cool Caps Industries is:
12% = ₹36m ÷ ₹303m (Based on past twelve months to March 2022).
“Yield” refers to a company’s earnings over the past year. This means that for every ₹1 of equity, the company generated ₹0.12 of profit.
Does Cool Caps Industries have a good ROE?
By comparing a company’s ROE with the average for its industry, we can get a quick measure of its quality. It is important to note that this measure is far from perfect, as companies differ significantly within the same industry classification. If you look at the image below, you can see that Cool Caps Industries has an ROE similar to the packaging industry classification average (12%).
So, although the ROE is not exceptional, it is at least acceptable. Even if the ROE is respectable compared to the industry, it is worth checking whether the company’s ROE is helped by high debt levels. If a company takes on too much debt, it runs a higher risk of defaulting on interest payments. To learn about the 3 risks we have identified for Cool Caps Industries, visit our risk dashboard for free.
The Importance of Debt to Return on Equity
Companies generally need to invest money 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, the debt necessary for growth will boost returns, but will not impact equity. This will make the ROE better than if no debt was used.
The debt of Cool Caps Industries and its ROE of 12%
Cool Caps Industries uses a high amount of debt to increase returns. Its debt to equity ratio is 1.25. The combination of a rather low ROE and heavy reliance on debt is not particularly attractive. Debt increases risk and reduces options for the business in the future, so you generally want to see good returns using it.
Summary
Return on equity is a useful indicator of a company’s ability to generate profits and return them to shareholders. In our books, the highest quality companies have a high return on equity, despite low leverage. 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.
But note: Cool Caps Industries may not be the best stock to buy. So take a look at this free list of interesting companies with high ROE 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.
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