Many investors are still learning the different metrics that can be helpful when analyzing a stock. This article is for those who want to know more about return on equity (ROE). As a learning-by-doing, we will look at ROE to better understand Verallia Société Anonyme (EPA:VRLA).
Return on equity or ROE is an important factor for a shareholder to consider as it tells them how much of their capital is being reinvested. In simpler terms, it measures a company’s profitability relative to equity.
Discover our latest analysis for Verallia Société Anonyme
How to calculate return on equity?
The ROE formula is:
Return on equity = Net income (from continuing operations) ÷ Equity
Thus, according to the formula above, the ROE of Verallia Société Anonyme is:
31% = €249m ÷ €800m (based on the last twelve months until December 2021).
The “yield” is the profit of the last twelve months. Another way to think about this is that for every $1 of equity, the company was able to make a profit of $0.31.
Does Verallia Société Anonyme have a good ROE?
Perhaps the easiest way to assess a company’s ROE is to compare it to the industry average. It is important to note that this measure is far from perfect, as companies differ significantly within the same industry classification. As shown in the image below, Verallia Société Anonyme posted a better ROE than the average (9.6%) for the Packaging industry.
That’s what we like to see. However, keep in mind that a high ROE does not necessarily indicate efficient profit generation. Especially when a company uses high levels of debt to finance its debt, which can increase its ROE, but the high leverage puts the company at risk. Our risk dashboard must include the 2 risks that we have identified for Verallia Société Anonyme.
What is the impact of debt on return on equity?
Most businesses need money – from somewhere – to increase their profits. This money can come from retained earnings, issuing new stock (shares), 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, debt used for growth will enhance returns, but will not affect total equity. In this way, the use of debt will increase ROE, even though the core economics of the business remains the same.
Combine the debt of Verallia Société Anonyme and its return on equity of 31%
Note Verallia Société Anonyme’s heavy reliance on debt, resulting in its debt-to-equity ratio of 2.21. Its ROE is quite impressive, but it probably would have been lower without the use of debt. Debt brings additional risk, so it’s only really worth it when a business is generating decent returns.
Return on equity is useful for comparing the quality of different companies. In our books, the highest quality companies have a high return on equity, despite low leverage. All things being equal, a higher ROE is better.
But when a company is of high quality, the market often gives it a price that reflects that. Earnings growth rates, relative to expectations reflected in the share price, are particularly important to consider. So I think it’s worth checking it out free analyst forecast report for the company.
If you’d rather check out another company – one with potentially superior finances – then don’t miss this free list of attractive companies, which have a high return on equity 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 only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.