While some investors are already well versed in financial metrics (hat tip),canon 80d with battery grip this article is for those who would like to learn about Return On Equity (ROE) and why it is important. We’ll use ROE to examine Triveni Engineering & Industries Limited (

NSE:TRIVENI

), by way of a worked example.

Triveni Engineering & Industries has a ROE of 2.7%

, based on the last twelve months. One way to conceptualize this, is that for each ₹1 of shareholders’ equity it has, the company made ₹0.027 in profit.

View our latest analysis for Triveni Engineering & Industries

How Do I Calculate Return On Equity?

The

formula for return on equity

is:

Return on Equity = Net Profit ÷ Shareholders’ Equity

Or for Triveni Engineering & Industries:

2.7% = 274.601 ÷ ₹10b (Based on the trailing twelve months to September 2018.)

Most know that net profit is the total earnings after all expenses, but the concept of shareholders’ equity is a little more complicated. 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 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. 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 Triveni Engineering & Industries 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, Triveni Engineering & Industries has a lower ROE than the average (9.3%) in the Food industry.

NSEI:TRIVENI Last Perf January 2nd 19

Unfortunately, that’s sub-optimal. We’d prefer see an ROE above the industry average, but it might not matter if the company is undervalued. Nonetheless, it could be useful to

double-check if insiders have sold shares recently

.

The Importance Of Debt To Return On Equity

Companies usually need to invest money to grow their profits. That cash can come from retained earnings, issuing 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 debt required for growth will boost returns, but will not impact the shareholders’ equity. In this manner the use of debt will boost ROE, even though the core economics of the business stay the same.

Story continues

Triveni Engineering & Industries’s Debt And Its 2.7% ROE

Triveni Engineering & Industries has a debt to equity ratio of 0.70, which is far from excessive. Its ROE is quite low, and the company already has some debt, so surely shareholders are hoping for an improvement. 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.

The Bottom Line On ROE

Return on equity is one way we can compare the business quality of different companies. Companies that can achieve high returns on equity without too much debt are generally of good quality. If two companies have around the same level of debt to equity, and one has a higher ROE, I’d generally prefer the one with higher ROE.

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. Profit growth rates, versus the expectations reflected in the price of the stock, are a particularly important to consider. So I think it may be worth checking this

free

this

detailed graph

of past earnings, revenue and cash flow

.

But note:

Triveni Engineering & Industries may not be the best stock to buy

. So take a peek at this

free

list of interesting companies with 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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