One of the best investments we can make is can you camp at lollapaloozain 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 Triveni Turbine Limited (

NSE:TRITURBINE

).

Our data shows

Triveni Turbine has a return on equity of 22%

for the last year. That means that for every ₹1 worth of shareholders’ equity, it generated ₹0.22 in profit.

Check out our latest analysis for Triveni Turbine

How Do You Calculate Return On Equity?

The

formula for ROE

is:

Return on Equity = Net Profit ÷ Shareholders’ Equity

Or for Triveni Turbine:

22% = 1038.69 ÷ ₹4.7b (Based on the trailing twelve months to September 2018.)

It’s easy to understand the ‘net profit’ part of that equation, but ‘shareholders’ equity’ requires further explanation. It is the capital paid in by shareholders, plus any retained earnings. Shareholders’ equity can be calculated by subtracting the total liabilities of the company from the total assets of the company.

What Does ROE Mean?

ROE measures a company’s profitability against the profit it retains, and any outside investments. The ‘return’ is the amount earned after tax over the last twelve months. The higher the ROE, the more profit the company is making. So, all else being equal,

a high ROE is better than a low one

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

Does Triveni Turbine Have A Good Return On Equity?

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. As you can see in the graphic below, Triveni Turbine has a higher ROE than the average (11%) in the Electrical industry.

NSEI:TRITURBINE Last Perf January 2nd 19

That’s clearly a positive. In my book, a high ROE almost always warrants a closer look. One data point to check is if

insiders have bought shares recently

.

Why You Should Consider Debt When Looking At 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 use of debt will improve the returns, but will not change the equity. In this manner the use of debt will boost ROE, even though the core economics of the business stay the same.

Story continues

Triveni Turbine’s Debt And Its 22% ROE

While Triveni Turbine does have a tiny amount of debt, with debt to equity of just 0.00004, we think the use of debt is very modest. Its very respectable ROE, combined with only modest debt, suggests the business is in good shape. 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 a useful indicator of the ability of a business to generate profits and return them to shareholders. In my book the highest quality companies have high return on equity, despite low debt. 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

.

Of course,

you might find a fantastic investment by looking elsewhere.

So take a peek at this

free

list of interesting companies.

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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