Is SIMPAR SA’s (BVMF:SIMH3) ROE of 28% above average?
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. As a learning-by-doing, we will look at ROE to better understand SIMPAR SA (BVMF:SIMH3).
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 is a profitability ratio that measures the rate of return on capital contributed by the company’s shareholders.
Check out our latest analysis for SIMPAR
How is ROE calculated?
The ROE formula is:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the above formula, the ROE for SIMPAR is:
28% = R$1.5 billion ÷ R$5.2 billion (based on the last twelve months until March 2022).
“Yield” refers to a company’s earnings over the past year. This therefore means that for every R$1 of investment by its shareholder, the company generates a profit of R$0.28.
Does SIMPAR 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. However, this method is only useful as a rough check, as companies differ quite a bit within the same industry classification. As the image below clearly shows, SIMPAR has a better ROE than the average (20%) for the transport industry.
This is clearly a positive point. That said, a high ROE does not always mean high profitability. Especially when a company uses high levels of debt to finance its debt, which can increase its ROE, but the high leverage puts the company at risk. You can see the 4 risks we have identified for SIMPAR by visiting our risk dashboard for free on our platform here.
Why You Should Consider Debt When Looking at ROE
Companies generally need to invest money to increase their profits. The money for the investment can come from the previous year’s earnings (retained earnings), from issuing new shares or from borrowing. In the first and second case, the ROE will reflect this use of cash for investment in the business. In the latter case, debt used for growth will enhance returns, but will not affect total equity. This will make the ROE better than if no debt was used.
SIMPAR’s debt and its ROE of 28%
We believe that SIMPAR uses a significant amount of debt to maximize its returns, as it has a significantly higher leverage ratio of 6.07. His ROE is decent, but once I consider all the debt, I’m not really impressed.
Return on equity is useful for comparing the quality of different companies. In our books, the highest quality companies have a high return on equity, despite low leverage. 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.
Sure, you might find a fantastic investment by looking elsewhere. So take a look at this free list of interesting companies.
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.