Should you be excited about the 25% return on equity of public joint-stock company Magnit (MCX: MGNT)?
While some investors are already familiar with financial metrics (hat tip), this article is for those who want to learn more about return on equity (ROE) and why it is important. To keep the lesson grounded in practicality, we will use ROE to better understand Magnit of the public joint stock company (MCX: MGNT).
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 review for Magnit
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, Magnit’s ROE is:
25% = ₽45b ÷ ₽182b (Based on the last twelve months up to September 2021).
The “return” is the profit of the last twelve months. This therefore means that for each RUB1 of the investments of its shareholder, the company generates a profit of RUB0.25.
Does Magnit have a good ROE?
By comparing a company’s ROE with its industry average, we can get a quick measure of its quality. However, this method is only useful as a rough check, as companies differ a lot within a single industry classification. As you can see in the graph below, Magnit has an above-average ROE (14%) for the supermarket sector.
This is what we love to see. However, keep in mind that a high ROE does not necessarily indicate efficient profit generation. Besides changes in net income, high ROE can also be the result of high leverage to equity, which indicates risk. You can see the 2 risks we have identified for Magnit by visiting our risk dashboard for free on our platform here.
Why You Should Consider Debt When Looking At ROE
Businesses generally need to invest money 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 first two cases, the ROE will capture this use of capital to grow. In the latter case, the debt used for growth will improve returns, but will not affect total equity. In this way, the use of debt will increase the ROE, even if the basic economy of the business remains the same.
Magnit’s debt and its 25% ROE
It appears that Magnit is using a huge volume of debt to fund the business, as his debt-to-equity ratio is extremely high at 3.46. His ROE is decent, but once I consider all the debt I’m not really impressed.
Return on equity is a useful indicator of a company’s ability to generate profits and return them to shareholders. In our books, the highest quality companies have a high return on equity, despite low leverage. If two companies have the same ROE, then I would generally prefer the one with the least amount of debt.
But when a company is of high quality, the market often offers it up to a price that reflects that. The rate at which earnings are likely to grow, relative to earnings growth expectations reflected in the current price, must also be considered. So I think it’s worth checking this out free analyst forecast report for the company.
But beware : Magnit 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.
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 the mentioned stocks.
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