Many investors are still educating themselves about the various metrics that can be useful when analyzing a stock. This article is for those who want to learn more about return on equity (ROE). As a learning by doing, we will look at the ROE to better understand Yincheng Life Service CO., Ltd. (HKG: 1922).

Return on equity or ROE is a key metric used to assess the efficiency with which the management of a business is using business capital. Simply put, it is used to assess a company’s profitability against its equity.

Check out our latest review for Yincheng Life Service

How is the 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 Yincheng Life Service is:

36% = CN ¥ 70m CN ¥ 196m (Based on the last twelve months up to December 2020).

The “return” is the income the business has earned over the past year. One way to conceptualize this is that for every HK $ 1 of shareholder capital it has, the company has made HK $ 0.36 in profit.

Does Yincheng Life Service have 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 shown in the image below, Yincheng Life Service has a better ROE than the real estate industry average (8.3%).

SEHK: 1922 Return on equity June 13, 2021

It’s a good sign. Keep in mind that a high ROE doesn’t always mean superior financial performance. Besides changes in net income, high ROE can also be the result of high leverage to equity, which indicates risk.

The importance of debt to return on equity

Almost all businesses need money to invest in the business, to increase their profits. The cash to be invested 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. This will make the ROE better than if no debt was used.

Combine Yincheng Life Service’s Debt and its 36% Return on Equity

Noteworthy is Yincheng Life Service’s high reliance on debt, resulting in a debt-to-equity ratio of 1.43. Its ROE is quite impressive, but it probably would have been lower without the use of debt. Leverage increases risk and reduces options for the business in the future, so you usually want to get good returns using it.

Conclusion

Return on equity is useful for comparing the quality of different companies. Firms that can earn high returns on equity without taking on too much debt are generally of good quality. All other things being equal, a higher ROE is preferable.

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. The rate at which earnings are likely to grow, relative to earnings growth expectations reflected in the current price, should also be considered. So I think it’s worth checking this out free analyst forecast report for the company.

But beware : Yincheng Life Service 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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