While some investors are already familiar with financial metrics (hat trick), this article is for those who want to learn more about return on equity (ROE) and why it matters. Through learning-by-doing, we will examine ROE to better understand HKT Trust and HKT Limited (HKG:6823).
Return on equity or ROE is a key metric used to gauge how effectively a company’s management is using the company’s capital. In other words, it reveals the company’s success in turning shareholders’ investments into profits.
See our latest analysis for HKT Trust and HKT
How to calculate return on equity?
Return on equity can be calculated using the formula:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the above formula, the ROE for HKT Trust and HKT is:
15% = HK$5.3 billion ÷ HK$37 billion (based on trailing 12 months to June 2021).
The “return” is the annual profit. Another way to think about this is that for every HK$1 of equity, the company was able to make a profit of HK$0.15.
Do HKT Trust and HKT have a good return on equity?
By comparing a company’s ROE with the average for its industry, we can get a quick measure of its quality. It is important to note that this measure is far from perfect, as companies differ significantly within the same industry classification. As you can see in the graph below, HKT Trust and HKT have an ROE above the average (4.5%) of the telecommunications sector.
It’s a good sign. Keep in mind that a high ROE does not always mean superior financial performance. Besides changes in net income, a high ROE can also be the result of high debt to equity, which indicates risk. To know the 2 risks we have identified for HKT Trust and HKT, visit our risk dashboard for free.
The Importance of Debt to Return on Equity
Companies generally need to invest money to increase their profits. This money can come from retained earnings, issuing new stock (shares), 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 use of debt will improve returns, but will not change equity. So using debt can improve ROE, but with the added risk of stormy weather, metaphorically speaking.
HKT Trust and HKT Debt and its 15% ROE
HKT Trust and HKT clearly use a high amount of debt to boost returns as it has a leverage ratio of 1.19. While its ROE is respectable, it’s worth bearing in mind that there’s usually a limit to the amount of debt a company can use. Debt brings additional risk, so it’s only really worth it when a business is generating decent returns.
Conclusion
Return on equity is a useful indicator of a company’s ability to generate profits and return them to shareholders. Companies that can earn high returns on equity without too much debt are generally of good quality. If two companies have roughly the same level of debt and one has a higher ROE, I generally prefer the one with a higher ROE.
But when a company is of high quality, the market often gives it a price that reflects that. Earnings growth rates, relative to expectations reflected in the share price, are particularly important to consider. You might want to check out this FREE analyst forecast visualization for the company.
If you’d rather check out another company – one with potentially superior finances – then don’t miss this free list of attractive companies, which have a high return on equity and low debt.
Feedback on this article? Concerned about content? Get in touch with us directly. You can also email the editorial team (at) Simplywallst.com.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.
Comments are closed.