While some investors are already familiar with financial metrics (hat tip), this article is for those who want to learn about return on equity (ROE) and its importance. To better understand Singapore Technologies Engineering Ltd (SGX:S63), he takes a learn-by-doing look at ROE.
Return on equity or ROE tests how effectively a company is growing its value and managing investors’ money. More simply, it measures a company’s profitability in relation to shareholder equity.
Check out our latest analysis for Singapore Technologies Engineering.
How do I calculate return on equity?
of ROE calculation formula teeth:
Return on equity = Net income (from continuing operations) ÷ Shareholders’ equity
So, based on the above formula, the ROE for Singapore Technologies Engineering is:
20% = S$546 million ÷ S$2.7 billion (based on trailing twelve months to June 2023).
“Return” is the profit over the past 12 months. This means that for every S$1 of a shareholder’s investment, the company will generate a profit of S$0.20 for him.
Does Singapore Technologies Engineering have a high return on equity?
Perhaps the easiest way to assess a company’s ROE is to compare it with the average for its industry. Importantly, this is far from a perfect measure, as companies vary widely even within the same industry classification. Pleasingly, Singapore Technologies Engineering’s ROE is better than the average (8.0%) in the Aerospace & Defense industry.
That’s what we want. Note that a high ROE does not necessarily mean good financial performance. Apart from changes in net income, a high ROE can also be a result of high debt relative to equity, which indicates risk. The risks dashboard should include the two risks he identified for Singapore Technologies Engineering.
The importance of debt to increase return on equity
Most companies need money from somewhere to grow their profits. That cash may come from issuing equity, retained earnings, or debt. For the first and second options, ROE reflects the use of cash for growth. In the latter case, using debt increases returns but does not change equity. If we do that, our ROE will be better than if we didn’t take out debt.
Singapore Technologies Engineering’s debt and ROE of 20%
Singapore Technologies Engineering uses a large amount of debt to increase its profits. The debt-to-equity ratio is 2.27. While ROE is impressive, it’s worth bearing in mind that there’s usually a limit to the amount of debt a company can use. Credit markets change over time, so investors should carefully consider how a company would perform if it could not borrow as easily.
conclusion
Return on equity helps you compare the quality of different businesses. According to our book, the highest quality companies have a higher return on equity despite having less debt. All else being equal, a higher ROE is better.
However, ROE is only one piece of a larger puzzle, as high quality companies often trade at high multiples of earnings. You should also consider the rate at which earnings are likely to grow compared to the expected earnings growth reflected in the current price. So you might want to check out this free visualization of analyst forecasts for the company.
However, please note: Singapore Technologies Engineering may not be the best stock to buy.So take a look at this free List of interesting companies with high ROE and low debt.
Valuation is complex, but we help make it simple.
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This article by Simply Wall St is general in nature. We provide commentary using only unbiased methodologies, based on historical data and analyst forecasts, and articles are not intended to be financial advice. This is not a recommendation to buy or sell any stock, and does not take into account your objectives or financial situation. We aim to provide long-term, focused analysis based on fundamental data. Note that our analysis may not factor in the latest announcements or qualitative material from price-sensitive companies. Simply Wall St has no position in any stocks mentioned.