Should you be impressed by the ROE of CIE Automotive, SA (BME:CIE)?
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 CIE Automotive, SA (BME: CIE).
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 short, ROE shows the profit that each dollar generates in relation to the investments of its shareholders.
See our latest analysis for CIE Automotive
How is ROE calculated?
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 CIE Automotive is:
21% = €292M ÷ €1.4B (based on trailing 12 months to December 2021).
“Yield” is the income the business has earned over the past year. This means that for every €1 of equity, the company generated €0.21 of profit.
Does CIE Automotive have a good return on equity?
Perhaps the easiest way to assess a company’s ROE is to compare it to the industry average. The limitation of this approach is that some companies are very different from others, even within the same industrial classification. As you can see in the graph below, CIE Automotive has an ROE above the average (9.3%) for the automotive components industry.
This is clearly a positive point. 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. You can see the 3 risks we have identified for CIE Automotive 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. 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, the debt necessary for growth will boost returns, but will not impact equity. In this way, the use of debt will increase ROE, even though the core economics of the business remains the same.
CIE Automotive’s debt and its ROE of 21%
CIE Automotive is clearly using a high amount of debt to boost returns, as it has a debt-to-equity ratio of 1.64. While there is no doubt that its ROE is impressive, we would have been even more impressed if the company had achieved this with less debt. Debt brings additional risk, so it’s only really worth it when a business is generating decent returns.
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.
That said, while ROE is a useful indicator of a company’s quality, you’ll need to consider a whole host of factors to determine the right price to buy a stock. Earnings growth rates, relative to expectations reflected in the share price, are particularly important to consider. So I think it’s worth checking it out free analyst forecast report for the company.
But note: CIE Automotive 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.
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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.