One of the best investments we can make is in our own knowledge and skills. With that in mind, this article will discuss how we can use Return on Equity (ROE) to better understand a business. As a learning by doing, we’ll take a look at the ROE to better understand Orthex Oyj (HEL: ORTHEX).
ROE or return on equity is a useful tool to assess how effectively a company can generate the returns on investment it has received from its shareholders. In other words, it reveals the company’s success in turning shareholders’ investments into profits.
Check out our latest review for Orthex Oyj
How is the ROE calculated?
The formula for ROE is:
Return on equity = Net income (from continuing operations) ÷ Equity
Thus, based on the above formula, the ROE of Orthex Oyj is:
24% = 7.4 million euros ÷ 31 million euros (based on the last twelve months up to September 2021).
The “return” is the profit of the last twelve months. One way to conceptualize this is that for every € 1 of share capital it has, the company has made € 0.24 in profit.
Does Orthex Oyj have a good ROE?
By comparing a company’s ROE with its industry average, we can get a quick measure of its quality. It is important to note that this measure is far from perfect, as companies differ considerably within a single industry classification. As shown in the image below, Orthex Oyj has a better than average ROE (13%) in the consumer durables industry.
It’s a good sign. Keep in mind that a high ROE doesn’t always mean superior financial performance. Especially when a business uses high levels of leverage to finance its debt, which can increase its ROE, but high leverage puts the business at risk.
The importance of debt to return on equity
Almost all businesses need money to invest in the business, to increase their profits. This liquidity can come from the issuance of shares, retained earnings or debt. In the first two cases, the ROE will capture this use of capital to grow. In the latter case, the use of debt will improve returns, but will not affect equity. So, using debt can improve ROE, but with added risk in stormy weather, metaphorically speaking.
The debt of Orthex Oyj and its ROE of 24%
Although Orthex Oyj has some debt, with a debt-to-equity ratio of just 0.91, we wouldn’t say the debt is excessive. When I see high ROE fueled by modest debt, I suspect the business is high quality. Using debt wisely to improve returns can certainly be a good thing, even if it increases risk slightly and lowers future option.
Summary
Return on equity is one way to compare the business quality of different companies. A business that can earn a high return on equity without going into debt can be considered a high quality business. If two companies have the same ROE, I would generally prefer the one with the least amount of debt.
That said, while ROE is a useful indicator of how good a business is, you’ll need to look at a whole range of factors to determine the right price to buy a stock. The rate at which earnings are likely to grow, relative to earnings growth expectations reflected in the current price, should also be considered. So I think it’s worth checking this out free analyst forecast report for the company.
Sure Orthex Oyj May Not Be The Best Stock To Buy. So you might want to see this free collection of other companies with high ROE and low leverage.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.
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