One of the best investments we can make is in our own knowledge and skill set. With that in mind, this article will work through how we can use Return On Equity (ROE) to better understand a business. We’ll use ROE to examine Aspial Lifestyle Limited (Catalist:5UF), by way of a worked example.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders’ Equity
So, based on the above formula, the ROE for Aspial Lifestyle is:
14% = S$35m ÷ S$252m (Based on the trailing twelve months to December 2024).
The ‘return’ refers to a company’s earnings over the last year. Another way to think of that is that for every SGD1 worth of equity, the company was able to earn SGD0.14 in profit.
View our latest analysis for Aspial Lifestyle
By comparing a company’s ROE with its industry average, we can get a quick measure of how good it is. The limitation of this approach is that some companies are quite different from others, even within the same industry classification. You can see in the graphic below that Aspial Lifestyle has an ROE that is fairly close to the average for the Specialty Retail industry (15%).
That isn’t amazing, but it is respectable. Although the ROE is similar to the industry, we should still perform further checks to see if the company’s ROE is being boosted by high debt levels. If so, this increases its exposure to financial risk. You can see the 3 risks we have identified for Aspial Lifestyle by visiting our risks dashboard for free on our platform here.
Virtually all companies need money to invest in the business, to grow profits. The cash for investment can come from prior year profits (retained earnings), issuing new shares, or borrowing. 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 used for growth will improve returns, but won’t affect the total equity. Thus the use of debt can improve ROE, albeit along with extra risk in the case of stormy weather, metaphorically speaking.