One of the best investments we can make is in 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 Yorkton Equity Group Inc. (CVE:YEG).
Return on equity or ROE is a key measure used to assess how efficiently a company’s management is utilizing the company’s capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company’s shareholders.
View our latest analysis for Yorkton Equity Group
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders’ Equity
So, based on the above formula, the ROE for Yorkton Equity Group is:
21% = CA$5.8m ÷ CA$27m (Based on the trailing twelve months to September 2024).
The ‘return’ refers to a company’s earnings over the last year. So, this means that for every CA$1 of its shareholder’s investments, the company generates a profit of CA$0.21.
One simple way to determine if a company has a good return on equity is to compare it to the average for its industry. The limitation of this approach is that some companies are quite different from others, even within the same industry classification. As you can see in the graphic below, Yorkton Equity Group has a higher ROE than the average (10%) in the Real Estate industry.
That’s what we like to see. With that said, a high ROE doesn’t always indicate high profitability. Especially when a firm uses high levels of debt to finance its debt which may boost its ROE but the high leverage puts the company at risk. Our risks dashboardshould have the 4 risks we have identified for Yorkton Equity Group.
Virtually all companies need money to invest in the business, to grow profits. That cash can come from retained earnings, issuing new shares (equity), or debt. 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. That will make the ROE look better than if no debt was used.
It seems that Yorkton Equity Group uses a huge volume of debt to fund the business, since it has an extremely high debt to equity ratio of 3.67. Its ROE is pretty good, but given the impact of the debt, we’re less than enthused, overall.
