Should you be impressed with the ROE of BetterLife Holding Limited (HKG: 6909)?

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One of the best investments we can make is in our own knowledge and skills. With that in mind, this article will discuss how we can use Return on Equity (ROE) to better understand a business. To keep the lesson practical, we’ll use ROE to better understand BetterLife Holding Limited (HKG: 6909).

Return on equity or ROE is a test of how effectively a company increases its value and manages investor money. In other words, it reveals the company’s success in turning shareholders’ investments into profits.

See our latest analysis for BetterLife Holding

How to calculate return on equity?

The formula for ROE is:

Return on equity = Net income (from continuing operations) ÷ Equity

Thus, based on the above formula, the ROE of BetterLife Holding is:

24% = CN ¥ 465m CN ¥ 1.9b (Based on the last twelve months to June 2021).

The “return” is the income the business has earned over the past year. Another way to think about this is that for every HK $ 1 worth of equity, the company was able to make a profit of HK $ 0.24.

Does BetterLife Holding have a good return on equity?

By comparing a company’s ROE with its industry average, we can get a quick measure of its quality. The limitation of this approach is that some companies are very different from others, even within the same industry classification. As shown in the image below, BetterLife Holding has a better ROE than the specialty retail industry average (12%).

SEHK: 6909 Return on equity October 15, 2021

This is what we love to see. That said, high ROE doesn’t always indicate high profitability. A higher proportion of debt in a company’s capital structure can also result in high ROE, where high debt levels could represent a huge risk.

What is the impact of debt on return on equity?

Almost all businesses need money to invest in the business, to increase their profits. The money for the investment can come from the profits of the previous year (retained earnings), from the issuance of new shares or from loans. 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 necessary for growth will increase returns, but will have no impact on equity. In this way, the use of debt will increase the ROE, even if the basic economy of the business remains the same.

BetterLife Holding’s debt and its ROE of 24%

BetterLife Holding has a debt ratio of 0.15, which is far from excessive. Its ROE is very impressive, and given its modest debt, this suggests that the business is of high quality. The prudent use of debt to increase returns is often very good for shareholders. However, this could reduce the company’s ability to take advantage of future opportunities.

Summary

Return on equity is one way to compare the business quality of different companies. A business that can earn a high return on equity without going into debt could be considered a high quality business. If two companies have the same ROE, then I would generally prefer the one with the least amount of debt.

That said, while ROE is a useful indicator of how good a business is, you’ll need to look at a whole range of factors to determine the right price to buy a stock. Especially important to consider are the growth rates of earnings, relative to expectations reflected in the share price. You might want to take a look at this data-rich interactive chart of the forecast for the business.

Sure, you might find a fantastic investment looking elsewhere. So take a look at this free list of interesting companies.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.

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