While some investors are already well versed in financial metrics (hat tip),does german shepherds shed a lot 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 MIRC Electronics Limited (

NSE:MIRCELECTR

).

MIRC Electronics has a ROE of 1.5%

, based on the last twelve months. One way to conceptualize this, is that for each ₹1 of shareholders’ equity it has, the company made ₹0.015 in profit.

View our latest analysis for MIRC Electronics

How Do You Calculate Return On Equity?

The

formula for return on equity

is:

Return on Equity = Net Profit ÷ Shareholders’ Equity

Or for MIRC Electronics:

1.5% = 35.425 ÷ ₹2.3b (Based on the trailing twelve months to September 2018.)

It’s easy to understand the ‘net profit’ part of that equation, but ‘shareholders’ equity’ requires further explanation. It is all earnings retained by the company, plus any capital paid in by shareholders. You can calculate shareholders’ equity by subtracting the company’s total liabilities from its total assets.

What Does Return On Equity Mean?

ROE measures a company’s profitability against the profit it retains, and any outside investments. The ‘return’ is the profit over the last twelve months. A higher profit will lead to a higher ROE. So, as a general rule,

a high ROE is a good thing

. That means ROE can be used to compare two businesses.

Does MIRC Electronics Have A Good ROE?

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. As is clear from the image below, MIRC Electronics has a lower ROE than the average (11%) in the Consumer Durables industry.

NSEI:MIRCELECTR Last Perf January 3rd 19

That certainly isn’t ideal. We prefer it when the ROE of a company is above the industry average, but it’s not the be-all and end-all if it is lower. Still,

shareholders might want to check if insiders have been selling

.

How Does Debt Impact ROE?

Most companies need money — from somewhere — to grow their profits. That cash can come from issuing shares, retained earnings, or debt. In the first two cases, the ROE will capture this use of capital to grow. 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.

Story continues

Combining MIRC Electronics’s Debt And Its 1.5% Return On Equity

Although MIRC Electronics does use debt, its debt to equity ratio of 0.41 is still low. Its ROE is certainly on the low side, and since it already uses debt, we’re not too excited about the company. Conservative use of debt to boost returns is usually a good move for shareholders, though it does leave the company more exposed to interest rate rises.

But It’s Just One Metric

Return on equity is one way we can compare the business quality of different companies. 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.

But when a business is high quality, the market often bids it up to a price that reflects this. The rate at which profits are likely to grow, relative to the expectations of profit growth reflected in the current price, must be considered, too. Check the past profit growth by MIRC Electronics by looking at this

visualization of past earnings, revenue and cash flow

.

Of course

MIRC Electronics may not be the best stock to buy

. So you may wish to see this

free

collection of other companies that have high ROE and low debt.

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]

.

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