Many investors are still learning the different metrics that can be useful when analyzing a stock. This article is for those who want to know more about return on equity (ROE). To keep the lesson grounded in practicality, we will use ROE to better understand C&D International Investment Group Limited (Hong Kong:1908).
ROE or return on equity is a useful tool for evaluating how effectively a company can generate returns on the investment it has received from its shareholders. In other words, it is a profitability ratio that measures the rate of return on capital contributed by the company’s shareholders.
Our analysis indicates that 1908 is potentially undervalued!
How to calculate return on equity?
ROE can be calculated using the formula:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the above formula, the ROE for C&D International Investment Group is:
6.9% = CN¥4.9b ÷ CN¥70b (based on trailing 12 months to June 2022).
The “return” is the annual profit. One way to conceptualize this is that for every HK$1 of share capital it has, the company has made a profit of HK$0.07.
Does C&D International Investment Group have a good ROE?
A simple way to determine if a company has a good return on equity is to compare it to the average for its industry. It is important to note that this measure is far from perfect, as companies differ significantly within the same industry classification. If you look at the image below, you can see that C&D International Investment Group has an ROE similar to the average of the real estate sector ranking (6.8%).
It’s neither particularly good nor bad. Even if the ROE is respectable compared to the industry, it is worth checking whether the company’s ROE is helped by high debt levels. If true, this is more an indication of risk than potential. You can see the 3 risks we have identified for C&D International Investment Group by visiting our risk dashboard free on our platform here.
Why You Should Consider Debt When Looking at ROE
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 first and second case, the ROE will reflect this use of cash for investment in the business. In the latter case, the use of debt will improve returns, but will not change equity. In this way, the use of debt will increase ROE, even though the core economics of the business remains the same.
C&D International Investment Group’s debt and its 6.9% ROE
Of note is the heavy use of debt by C&D International Investment Group, leading to its debt-to-equity ratio of 1.19. The combination of a rather low ROE and heavy reliance on debt is not particularly attractive. Debt increases risk and reduces options for the business in the future, so you generally want to see good returns using it.
Return on equity is useful for comparing the quality of different companies. 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 ROE is only one piece of a larger puzzle, as high-quality companies often trade on high earnings multiples. The rate at which earnings are likely to grow, relative to earnings growth expectations reflected in the current price, should also be considered. So you might want to take a look at this data-rich interactive chart of business forecasts.
But note: C&D International Investment Group 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.
Valuation is complex, but we help make it simple.
Find out if C&D International Investment Group is potentially overvalued or undervalued by viewing our full analysis, which includes fair value estimates, risks and warnings, dividends, insider trading and financial health.
Feedback on this article? Concerned about content? Get in touch with us directly. You can also email the editorial team (at) Simplywallst.com.
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.