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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). We will use ROE to examine CCR SA (BVMF: CCRO3), through a worked example.
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 short, the ROE shows the profit that each dollar generates compared to the investments of its shareholders.
Check out our latest analysis for the CCR
How do you calculate return on equity?
the formula for ROE is:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the above formula, the ROE for CCR is:
9.8% = 875 million reais ÷ 8.9 billion reais (based on the last twelve months up to September 2021).
The “return” is the annual profit. One way to conceptualize this is that for every R $ 1 of shareholder capital it has, the company has made R $ 0.10 in profit.
Does CCR have a good return on equity?
An easy way to determine if a company has a good return on equity is to compare it to the average in its industry. It is important to note that this measure is far from perfect, as companies differ considerably within a single industry classification. The image below shows that CCR has an ROE that is roughly in line with the infrastructure sector average (9.1%).
So even if the ROE is not exceptional, it is at least acceptable. Even though the ROE is respectable compared to the industry, it is worth checking out if the company’s ROE is helped by high debt levels. If this is true, it is more an indication of risk than potential.
What is the impact of debt on return on equity?
Most businesses need the money – somewhere – to increase their profits. This liquidity can come from retained earnings, the issuance of new shares (equity) 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 use of debt will improve returns, but will not affect equity. In this way, the use of debt will increase the ROE, even if the basic economy of the business remains the same.
CCR’s debt and its ROE of 9.8%
Note the strong recourse to debt by CCR, which earned it a debt / equity ratio of 2.79. The combination of a rather low ROE and a high recourse to debt is not particularly attractive. Debt comes with additional risk, so it’s only really worth it when a business is making decent returns from it.
Conclusion
Return on equity is useful for comparing the quality of different companies. A business that can earn a high return on equity without going into debt can be considered a high quality business. 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.
But when a company is of high quality, the market often offers it up to a price that reflects that. It is important to take into account other factors, such as future profit growth and the amount of investment required for the future. So you might want to check out this FREE visualization of analyst forecasts for the business.
But beware : CCR 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 using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock 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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