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A Closer Look at Energiekontor AG’s (ETR:EKT) Impressive ROE
While some investors are already well-versed in financial metrics (tip), this article is for those who would like to learn about return on equity (ROE) and why it is important. To keep the lesson practical, we will use ROE to better understand Energiekontor AG (ETR:EKT).
Return on equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit that each dollar generates in relation to its shareholders’ investments.
See our latest analysis for Energiekontor
How is ROE calculated?
ROE can be calculated using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Equity
Therefore, based on the above formula, Energiekontor’s ROE is:
45% = €83 million ÷ €186 million (based on the trailing twelve months to December 2023).
The ‘return’ is the profit from the last twelve months. One way to conceptualize this is that for every €1 of shareholder capital it has, the company made €0.45 in profit.
Does Energiekontor have a good return on equity?
Probably the easiest way to evaluate a company’s ROE is to compare it to the industry average. The limitation of this approach is that some companies are quite different from others, even within the same industrial classification. As you can see in the chart below, Energiekontor has a higher than average ROE (14%) in the Electrical industry.
roe
This is a good sign. However, keep in mind that a high ROE does not necessarily indicate efficient profit generation. A higher proportion of debt in a company’s capital structure can also result in a high ROE, where high debt levels can pose a huge risk. Our risk dashboardit should have the 3 risks that we identified for Energiekontor.
The importance of debt for return on equity
Companies often need to invest money to increase their profits. This money can come from retained earnings, issuing new shares (equity) or debt. In the first two cases, ROE will capture this use of capital to grow. In the latter case, debt used for growth will improve returns but will not affect total capital. This will make the ROE look better than if no debt was used.
Energiekontor’s debt and its 45% ROE
Energiekontor clearly uses a high amount of debt to increase returns, as it has a debt-to-equity ratio of 1.67. Its ROE is quite impressive, but it likely would have been lower without the use of debt. Debt brings extra risks, so it’s only worth it when a company generates decent returns from it.
Conclusion
Return on equity is a way of comparing the quality of business of different companies. Companies that can achieve high returns on equity without too much debt are generally of good quality. If two companies have roughly the same level of debt to equity, and one of them has a higher ROE, I generally prefer the one with the higher ROE.
The story continues
But ROE is just one piece of a larger puzzle, as high-quality companies often trade at high earnings multiples. The rate at which earnings are likely to grow, relative to the earnings growth expectations reflected in the current price, should also be considered. So you might want to take a look at this interactive graph rich in forecast data for the company.
But note: Energiekontor 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 using only an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take into account your objectives or your financial situation. Our goal is to bring you long-term focused analysis driven by fundamental data. Please note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Simply Wall St has no position in any of the stocks mentioned.