One of the best investments we can make is in our own knowledge and skill set. With that in mind, this article will work through how we can use Return On Equity (ROE) to better understand a business. By way of learning-by-doing, we’ll look at ROE to gain a better understanding of KION GROUP AG (ETR:KGX).
Return on equity or ROE is a key measure used to assess how efficiently a company’s management is utilizing the company’s capital. In simpler terms, it measures the profitability of a company in relation to shareholder’s equity.
Check out our latest analysis for KION GROUP
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders’ Equity
So, based on the above formula, the ROE for KION GROUP is:
5.8% = €342m ÷ €5.9b (Based on the trailing twelve months to September 2024).
The ‘return’ is the amount earned after tax over the last twelve months. So, this means that for every €1 of its shareholder’s investments, the company generates a profit of €0.06.
Arguably the easiest way to assess company’s ROE is to compare it with the average in its industry. Importantly, this is far from a perfect measure, because companies differ significantly within the same industry classification. If you look at the image below, you can see KION GROUP has a lower ROE than the average (10%) in the Machinery industry classification.
That’s not what we like to see. However, a low ROE is not always bad. If the company’s debt levels are moderate to low, then there’s still a chance that returns can be improved via the use of financial leverage. A company with high debt levels and low ROE is a combination we like to avoid given the risk involved. To know the 2 risks we have identified for KION GROUP visit our risks dashboard for free.
Most companies need money — from somewhere — to grow their profits. That cash can come from issuing shares, retained earnings, or debt. In the case of the first and second options, the ROE will reflect this use of cash, for growth. In the latter case, the use of debt will improve the returns, but will not change the equity. That will make the ROE look better than if no debt was used.
KION GROUP clearly uses a high amount of debt to boost returns, as it has a debt to equity ratio of 1.09. The combination of a rather low ROE and significant use of debt is not particularly appealing. Debt does bring extra risk, so it’s only really worthwhile when a company generates some decent returns from it.
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