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. We’ll use ROE to examine Aditya Birla Fashion and Retail Limited (NSE:ABFRL), by way of a worked example.
Over the last twelve months Aditya Birla Fashion and Retail has recorded a ROE of 13%. One way to conceptualize this, is that for each ₹1 of shareholders’ equity it has, the company made ₹0.13 in profit.
Return on Equity = Net Profit ÷ Shareholders’ Equity
Or for Aditya Birla Fashion and Retail:
13% = ₹1.4b ÷ ₹10.9b (Based on the trailing twelve months to June 2018.)
Most readers would understand what net profit is, but it’s worth explaining the concept of shareholders’ equity. It is all earnings retained by the company, plus any capital paid in by shareholders. Shareholders’ equity can be calculated by subtracting the total liabilities of the company from the total assets of the company.
What Does Return On Equity Signify?
ROE measures a company’s profitability against the profit it retains, and any outside investments. The ‘return’ is the yearly profit. A higher profit will lead to a higher ROE. So, all else being equal, a high ROE is better than a low one. That means it can be interesting to compare the ROE of different companies.
Does Aditya Birla Fashion and Retail Have A Good Return On Equity?
One simple way to determine if a company has a good return on equity is to compare it to the average for its industry. However, this method is only useful as a rough check, because companies do differ quite a bit within the same industry classification. As is clear from the image below, Aditya Birla Fashion and Retail has a better ROE than the average (7.4%) in the luxury industry.