One of the best investments we can make is indian runner ducks fawn and whitein our own knowledge and skill set. With that in mind, this article will work through how we can use Return On Equity (ROE) to better understand a business. To keep the lesson grounded in practicality, we’ll use ROE to better understand B+S Banksysteme Aktiengesellschaft (

FRA:DTD2

).

Our data shows

B+S Banksysteme has a return on equity of 8.1%

for the last year. One way to conceptualize this, is that for each €1 of shareholders’ equity it has, the company made €0.081 in profit.

View our latest analysis for B+S Banksysteme

How Do You Calculate ROE?

The

formula for ROE

is:

Return on Equity = Net Profit ÷ Shareholders’ Equity

Or for B+S Banksysteme:

8.1% = 1.068 ÷ €13m (Based on the trailing twelve months to June 2018.)

Most readers would understand what net profit is, but it’s worth explaining the concept of shareholders’ equity. It is the capital paid in by shareholders, plus any retained earnings. Shareholders’ equity can be calculated by subtracting the total liabilities of the company from the total assets of the company.

What Does ROE Mean?

Return on Equity measures a company’s profitability against the profit it has kept for the business (plus any capital injections). The ‘return’ is the profit over the last twelve months. The higher the ROE, the more profit the company is making. So, all else equal,

investors should like a high ROE

. Clearly, then, one can use ROE to compare different companies.

Does B+S Banksysteme 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. Importantly, this is far from a perfect measure, because companies differ significantly within the same industry classification. The image below shows that B+S Banksysteme has an ROE that is roughly in line with the Software industry average (8.1%).

DB:DTD2 Last Perf January 2nd 19

That isn’t amazing, but it is respectable. ROE can give us a view about company quality, but many investors also look to other factors, such as whether there are insiders buying shares. If you are like me, then you will

not

want to miss this

free

list of growing companies that insiders are buying.

Why You Should Consider Debt When Looking At ROE

Most companies need money — from somewhere — to grow their profits. The cash for investment can come from prior year profits (retained earnings), issuing new shares, or borrowing. In the first and second cases, the ROE will reflect this use of cash for investment in the business. In the latter case, the debt required for growth will boost returns, but will not impact the shareholders’ equity. That will make the ROE look better than if no debt was used.

Story continues

Combining B+S Banksysteme’s Debt And Its 8.1% Return On Equity

B+S Banksysteme has a debt to equity ratio of 0.40, which is far from excessive. I’m not impressed with its ROE, but the debt levels are not too high, indicating the business has decent prospects. Judicious use of debt to improve returns can certainly be a good thing, although it does elevate risk slightly and reduce future optionality.

But It’s Just One Metric

Return on equity is useful for comparing the quality of different businesses. A company that can achieve a high return on equity without debt could be considered a high quality business. All else being equal, a higher ROE is better.

Having said that, while ROE is a useful indicator of business quality, you’ll have to look at a whole range of factors to determine the right price to buy a stock. It is important to consider other factors, such as future profit growth — and how much investment is required going forward. So I think it may be worth checking this

free

report on analyst forecasts for the company

.

Of course,

you might find a fantastic investment by looking elsewhere.

So take a peek at this

free

list of interesting companies.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at

[email protected]

.

View comments