Is Aquafil SpA’s ROE (BIT: ECNL) of 8.0% above average?
While some investors are already familiar with financial metrics (hat tip), this article is for those who want to learn more about return on equity (ROE) and why it is important. To keep the lesson grounded in practice, we will use the ROE to better understand Aquafil SpA (BIT: ECNL).
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.
See our latest review for Aquafil
How do you calculate return on equity?
The return on equity formula is:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the above formula, Aquafil’s ROE is:
8.0% = 11 million euros ÷ 143 million euros (based on the last twelve months up to June 2021).
The “return” is the income the business has earned over the past year. This therefore means that for 1 € of investment by its shareholder, the company generates a profit of 0.08 €.
Does Aquafil 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. If you look at the image below, you can see that Aquafil has an ROE similar to the luxury industry classification average (8.0%).
It’s no wonder, but it’s respectable. While at least the ROE is not lower than that of the industry, it is still worth checking out the role that corporate debt plays, as high levels of debt relative to equity can also make the ROE appear high. If so, it increases their exposure to financial risk. Our risk dashboard must include the 2 risks that we have identified for Aquafil.
What is the impact of debt on return on equity?
Most businesses need money – from somewhere – to increase their profits. This liquidity can come from retained earnings, the issuance of new shares (equity) or debt. In the first and second cases, the ROE will reflect this use of cash for investing in the business. 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.
Aquafil’s debt and its ROE of 8.0%
Aquafil clearly uses a high amount of debt to increase returns, as it has a debt-to-equity ratio of 2.33. With a fairly low ROE and heavy use of debt, it’s hard to get excited about this business right now. Investors should think carefully about how a business will perform if it weren’t able to borrow so easily, as credit markets change over time.
Return on equity is a useful indicator of a company’s ability to generate profits and return them to shareholders. A business that can earn a high return on equity without going into debt could be considered a high quality business. If two companies have the same ROE, then I would generally prefer the one with the least amount of debt.
That said, while ROE is a useful indicator of how good a business is, you’ll need to look at a whole range of factors to determine the right price to buy a stock. 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 this out free analyst forecast report for the company.
If you would rather consult with another company – one with potentially superior finances – then don’t miss this free list of interesting companies, which have a HIGH return on equity and low leverage.
When trading Aquafil or any other investment, use the platform considered by many to be the gateway for professionals to the global market, Interactive Brokers. You get the cheapest * trading on stocks, options, futures, forex, bonds and funds from around the world from a single integrated account. Promoted
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 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 the mentioned stocks.
*Interactive Brokers Ranked Least Expensive Broker By StockBrokers.com Online Annual Review 2020
Do you have any feedback on this item? Are you worried about the content? Get in touch with us directly. You can also send an email to the editorial team (at) simplywallst.com.