One of the best investments we can make is super sculpey bake timein 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. To keep the lesson grounded in practicality, we’ll use ROE to better understand Avidly Oyj (

HEL:AVIDLY

).

Avidly Oyj has a ROE of 15%

, based on the last twelve months. One way to conceptualize this, is that for each €1 of shareholders’ equity it has, the company made €0.15 in profit.

View our latest analysis for Avidly Oyj

How Do You Calculate ROE?

The

formula for ROE

is:

Return on Equity = Net Profit ÷ Shareholders’ Equity

Or for Avidly Oyj:

15% = 0.543 ÷ €3.6m (Based on the trailing twelve months to June 2018.)

Most readers would understand what net profit is, but it’s worth explaining the concept of shareholders’ equity. It is the capital paid in by shareholders, plus any retained earnings. You can calculate shareholders’ equity by subtracting the company’s total liabilities from its total assets.

What Does Return On Equity Mean?

Return on Equity measures a company’s profitability against the profit it has kept for the business (plus any capital injections). The ‘return’ is the yearly profit. A higher profit will lead to a higher ROE. So, as a general rule,

a high ROE is a good thing

. That means ROE can be used to compare two businesses.

Does Avidly Oyj Have A Good ROE?

One 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, because companies do differ quite a bit within the same industry classification. If you look at the image below, you can see Avidly Oyj has a similar ROE to the average in the Media industry classification (15%).

HLSE:AVIDLY Last Perf January 2nd 19

That isn’t amazing, but it is respectable. ROE doesn’t tell us if the share price is low, but it can inform us to the nature of the business. For those looking for a bargain, other factors may be more important. If you are like me, then you will

not

want to miss this

free

list of growing companies that insiders are buying.

How Does Debt Impact ROE?

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 required for growth will boost returns, but will not impact the shareholders’ equity. In this manner the use of debt will boost ROE, even though the core economics of the business stay the same.

Story continues

Combining Avidly Oyj’s Debt And Its 15% Return On Equity

Avidly Oyj has a debt to equity ratio of 0.82, which is far from excessive. The combination of modest debt and a very respectable ROE suggests this is a business worth watching. Conservative use of debt to boost returns is usually a good move for shareholders, though it does leave the company more exposed to interest rate rises.

In Summary

Return on equity is useful for comparing the quality of different businesses. Companies that can achieve high returns on equity without too much debt are generally of good quality. All else being equal, a higher ROE is better.

Having said that, while ROE is a useful indicator of business quality, you’ll have to look at a whole range of factors to determine the right price to buy a stock. It is important to consider other factors, such as future profit growth — and how much investment is required going forward. So you might want to check this FREE

visualization of analyst forecasts for the company

.

But note:

Avidly Oyj may not be the best stock to buy

. So take a peek at this

free

list of interesting companies with high ROE and low debt.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at

[email protected]

.

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