Should you be excited about the 21% return on equity of China Risun Group Limited (HKG: 1907)?
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. To keep the lesson grounded in practicality, we will use ROE to better understand China Risun Group Limited (HKG:1907).
Return on equity or ROE is an important factor for a shareholder to consider as it tells them how much of their capital is being reinvested. In simpler terms, it measures a company’s profitability relative to equity.
Check opportunities and risks within the HK chemical industry.
How do you calculate return on equity?
The ROE formula is:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the above formula, the ROE for China Risun Group is:
21% = CN¥2.6b ÷ CN¥13b (Based on trailing twelve months to June 2022).
The “yield” is the amount earned after tax over the last twelve months. Another way to think about this is that for every HK$1 of equity, the company was able to make a profit of HK$0.21.
Does China Risun Group have a good return on equity?
A simple way to determine if a company has a good return on equity is to compare it to the average for its industry. The limitation of this approach is that some companies are very different from others, even within the same industrial classification. Fortunately, China Risun Group has an above-average ROE (13%) for the chemical industry.
It’s a good sign. That said, a high ROE does not always mean high profitability. A higher proportion of debt in a company’s capital structure can also result in a high ROE, where high debt levels could be a huge risk. You can see the 3 risks we have identified for China Risun Group by visiting our risk dashboard for free on our platform here.
The Importance of Debt to Return on Equity
Most businesses need money – from somewhere – to increase their profits. This money can come from retained earnings, issuing new stock (shares), or debt. 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.
The debt of the Chinese group Risun and its ROE of 21%
China Risun Group uses a high amount of debt to increase returns. Its debt to equity ratio is 1.59. There’s no doubt that its ROE is decent, but the company’s sky-high debt isn’t too exciting to see. Investors need to think carefully about how a company would perform if it weren’t able to borrow so easily, as credit markets change over time.
Return on equity is a useful indicator of a company’s ability to generate profits and return them to shareholders. A company that can earn a high return on equity without going into debt could be considered a high quality company. If two companies have the same ROE, I would generally prefer the one with less debt.
But when a company is of high quality, the market often gives it a price that reflects that. Earnings growth rates, relative to expectations reflected in the share price, are particularly important to consider. You can see how the company has grown in the past by watching this FREE detailed graph past profits, revenue and cash flow.
Sure, you might find a fantastic investment by looking elsewhere. So take a look at this free list of interesting companies.
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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.
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