Should you be excited about the 26% return on equity of Bureau Veritas SA (EPA:BVI)?

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While some investors are already familiar with financial metrics (hat trick), this article is for those who want to learn more about return on equity (ROE) and why it matters. We will use ROE to examine Bureau Veritas SA (EPA:BVI), as a concrete example.

Return on Equity or ROE is a test of how effectively a company increases its value and manages investors’ money. In other words, it is a profitability ratio that measures the rate of return on capital contributed by the company’s shareholders.

Discover our latest analysis for Bureau Veritas

How to calculate return on equity?

Return on equity can be calculated using the formula:

Return on equity = Net income (from continuing operations) ÷ Equity

So, based on the formula above, the ROE for Bureau Veritas is:

26% = €446 million ÷ €1.7 billion (based on the last twelve months until December 2021).

The “yield” is the amount earned after tax over the last twelve months. This therefore means that for every €1 of investment by its shareholder, the company generates a profit of €0.26.

Does Bureau Veritas have a good return on equity?

A simple way to determine if a company has a good return on equity is to compare it to the average for its industry. However, this method is only useful as a rough check, as companies differ quite a bit within the same industry classification. As the image below clearly shows, Bureau Veritas has a better ROE than the average (16%) for the professional services industry.

ENXTPA:BVI Return on Equity March 31, 2022

That’s what we like to see. Keep in mind that a high ROE does not always mean superior financial performance. 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. To find out about the 2 risks we have identified for Bureau Veritas, visit our risk dashboard for free.

The Importance of Debt to Return on Equity

Companies generally need to invest money to increase their profits. This money can come from retained earnings, issuing new stock (shares), or debt. In the first two cases, the ROE will capture this use of capital to grow. In the latter case, the debt necessary for growth will boost returns, but will not impact equity. Thus, the use of debt can improve ROE, but with an additional risk in the event of a storm, metaphorically speaking.

Bureau Veritas’ debt and its ROE of 26%

Bureau Veritas uses a high amount of debt to increase returns. Its debt to equity ratio is 1.45. While there is no doubt that its ROE is impressive, we would have been even more impressed if the company had achieved this with less debt. Investors need to think carefully about how a company would perform if it weren’t able to borrow so easily, as credit markets change over time.

Summary

Return on equity is a useful indicator of a company’s ability to generate profits and return them to shareholders. Companies that can earn high returns on equity without too much debt are generally of good quality. 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. The rate at which earnings are likely to grow, relative to earnings growth expectations reflected in the current price, should also be considered. You might want to take a look at this data-rich interactive chart of the company’s forecast.

But note: Bureau Veritas may not be the best stock to buy. So take a look at this free list of interesting companies with high ROE and low debt.

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.

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