Should We Be Cautious About Tipiak Société Anonyme's (EPA:TIPI) ROE Of 5.0%?

Many investors are still learning about the various metrics that can be useful when analysing a stock. This article is for those who would like to learn about Return On Equity (ROE). We'll use ROE to examine Tipiak Société Anonyme (EPA:TIPI), by way of a worked example.

Tipiak Société Anonyme has a ROE of 5.0%, based on the last twelve months. That means that for every €1 worth of shareholders' equity, it generated €0.05 in profit.

View our latest analysis for Tipiak Société Anonyme

How Do You Calculate ROE?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

Or for Tipiak Société Anonyme:

5.0% = €2.4m ÷ €48m (Based on the trailing twelve months to June 2019.)

Most readers would understand what net profit is, but it’s worth explaining the concept of shareholders’ equity. It is all the money paid into the company from shareholders, plus any earnings retained. The easiest way to calculate shareholders' equity is to subtract the company's total liabilities from the total assets.

What Does Return On Equity Mean?

ROE measures a company's profitability against the profit it retains, and any outside investments. The 'return' is the amount earned after tax over the last twelve months. A higher profit will lead to a higher ROE. So, all else equal, investors should like a high ROE. That means it can be interesting to compare the ROE of different companies.

Does Tipiak Société Anonyme Have A Good ROE?

Arguably the easiest way to assess company's ROE is to compare it with the average in its industry. The limitation of this approach is that some companies are quite different from others, even within the same industry classification. As shown in the graphic below, Tipiak Société Anonyme has a lower ROE than the average (7.1%) in the Food industry classification.

That's not what we like to see. We'd prefer see an ROE above the industry average, but it might not matter if the company is undervalued. Still, shareholders might want to check if insiders have been selling.

How Does Debt Impact Return On Equity?

Most companies need money -- from somewhere -- to grow their profits. That cash can come from issuing shares, retained earnings, or debt. In the first two cases, the ROE will capture this use of capital to grow. In the latter case, the use of debt will improve the returns, but will not change the equity. In this manner the use of debt will boost ROE, even though the core economics of the business stay the same.

Combining Tipiak Société Anonyme's Debt And Its 5.0% Return On Equity

Tipiak Société Anonyme clearly uses a significant amount of debt to boost returns, as it has a debt to equity ratio of 1.04. Its ROE isn't too bad, but it would probably be very disappointing if the company had to stop using debt. Investors should think carefully about how a company might perform if it was unable to borrow so easily, because credit markets do change over time.

But It's Just One Metric

Return on equity is a useful indicator of the ability of a business to generate profits and return them to shareholders. Companies that can achieve high returns on equity without too much debt are generally of good quality. If two companies have the same ROE, then I would generally prefer the one with less debt.

But when a business is high quality, the market often bids it up to a price that reflects this. It is important to consider other factors, such as future profit growth -- and how much investment is required going forward. So you might want to take a peek at this data-rich interactive graph of forecasts for the company.

Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of interesting companies.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.