Should you be excited about the 24% return on equity of Digital Value SpA (BIT:DGV)?
One of the best investments we can make is in our own knowledge and skills. With that in mind, this article will explain 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 Digital Value SpA (BIT:DGV).
Return on equity or ROE is an important factor for a shareholder to consider as it tells them how much of their capital is being reinvested. In other words, it reveals the company’s success in turning shareholders’ investments into profits.
Check out our latest digital value analysis
How do you calculate return on equity?
the return on equity formula is:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the above formula, the ROE for the numerical value is:
24% = €31m ÷ €129m (based on the last twelve months to December 2021).
The “yield” is the amount earned after tax over the last twelve months. This therefore means that for every €1 of investment by its shareholder, the company generates a profit of €0.24.
Does the numerical value have a good return on equity?
Perhaps the easiest way to assess a company’s ROE is to compare it to the industry average. It is important to note that this measure is far from perfect, as companies differ significantly within the same industry classification. As the image below clearly shows, Digital Value has a better ROE than the software industry average (14%).
That’s what we like to see. That said, a high ROE does not always mean high profitability. A higher proportion of debt in a company’s capital structure can also result in a high ROE, where high debt levels could be a huge risk. You can see the 2 risks we have identified for digital value by visiting our risk dashboard for free on our platform here.
The Importance of Debt to Return on Equity
Virtually all businesses need money to invest in the business, to increase their profits. This money can come from retained earnings, issuing new stock (shares), or debt. In the first two cases, the ROE will capture this use of capital to grow. In the latter case, the use of debt will improve returns, but will not change equity. This will make the ROE better than if no debt was used.
Digital Value’s debt and its ROE of 24%
Although Digital Value has some debt, with a debt-to-equity ratio of just 0.70, we wouldn’t say the debt is excessive. When I see a high ROE fueled by modest debt, I suspect the company is high quality. Judicious use of debt to improve returns can certainly be a good thing, even if it slightly increases risk and reduces future optionality.
Return on equity is a way to compare the business quality of different companies. Companies that can earn high returns on equity without too much debt are generally of good quality. If two companies have the same ROE, I would generally prefer the one with less debt.
But ROE is only one piece of a larger puzzle, as high-quality companies often trade on high earnings multiples. The rate at which earnings are likely to grow, relative to earnings growth expectations reflected in the current price, should also be considered. 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.
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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.