While some investors are already well versed in financial metrics (hat tip), this article is for those who would like to learn about Return On Equity (ROE) and why it is important. By way of learning-by-doing, we’ll look at ROE to gain a better understanding of Freelance.com SA ( EPA:ALFRE ). Over the last twelve months Freelance.com has recorded a ROE of 13% . Another way to think of that is that for every €1 worth of equity in the company, it was able to earn €0.13. How Do I Calculate Return On Equity? The formula for ROE is: Return on Equity = Net Profit ÷ Shareholders’ Equity Or for Freelance.com: 13% = €4.4m ÷ €34m (Based on the trailing twelve months to December 2018.) Most know that net profit is the total earnings after all expenses, but the concept of shareholders’ equity is a little more complicated. It is all the money paid into the company from shareholders, plus any earnings retained. You can calculate shareholders’ equity by subtracting the company’s total liabilities from its total assets. What Does ROE Mean? ROE measures a company’s profitability against the profit it retains, and any outside investments. The ‘return’ is the yearly profit. The higher the ROE, the more profit the company is making. So, as a general rule, a high ROE is a good thing . That means ROE can be used to compare two businesses. Does Freelance.com Have A Good ROE? Arguably the easiest way to assess company’s ROE is to compare it with the average in its industry. However, this method is only useful as a rough check, because companies do differ quite a bit within the same industry classification. The image below shows that Freelance.com has an ROE that is roughly in line with the Professional Services industry average (16%). ENXTPA:ALFRE Past Revenue and Net Income, September 21st 2019 That’s neither particularly good, nor bad. 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 like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them). How Does Debt Impact ROE? Virtually all companies need money to invest in the business, to grow profits. That cash 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 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. Combining Freelance.com’s Debt And Its 13% Return On Equity While Freelance.com does have some debt, with debt to equity of just 0.34, we wouldn’t say debt is excessive. Its very respectable ROE, combined with only modest debt, suggests the business is […]
