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). Learning by doing, we will look at ROEs to better understand the National Marine Dredging Company (ADX: NMDC).
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.
Check out our latest analysis for National Marine Dredging
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 formula above, the ROE for domestic marine dredging is:
18% = د.إ1.0b ÷ د.إ5.5b (Based on the last twelve months to December 2021).
The “return” is the annual profit. This therefore means that for each AED1 of its shareholder’s investments, the company generates a profit of AED0.18.
Does National Marine Dredging 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, National Marine Dredging has a better ROE than the construction industry average (8.2%).
This is clearly a positive point. Keep in mind that a high ROE does not always mean superior financial performance. A higher proportion of debt in a company’s capital structure can also result in a high ROE, where high debt levels could be a huge risk.
What is the impact of debt on ROE?
Companies generally need to invest money to increase their profits. This money can come from issuing 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 debt necessary for growth will boost returns, but will not impact equity. In this way, the use of debt will increase ROE, even though the core economics of the business remains the same.
National Marine Dredging’s debt and its 18% ROE
Although National Marine Dredging uses debt, its debt-to-equity ratio of 0.36 is still low. The combination of modest debt and a very respectable ROE suggests that this is activity to watch. Prudent use of debt to boost returns is generally a good move for shareholders, even if it leaves the company more exposed to rising interest rates.
Return on equity is useful for comparing the quality of different companies. A company that can earn a high return on equity without going into debt could be considered a high quality company. All things being equal, a higher ROE is better.
That said, while ROE is a useful indicator of a company’s quality, you’ll need to consider a whole host 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. You might want to take a look at this data-rich interactive chart of the company’s forecast.
Sure National Marine Dredging may not be the best stock to buy. So you might want to see this free collection of other companies that have high ROE 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.