【steamgifts sort by value】Should ECI Technology Holdings Limited (HKG:8013) Focus On Improving This Fundamental Metric?

Many investors are still learning about the various metrics that can be useful when analysing a stock. This steamgifts sort by valuearticle is for those who would like to learn about Return On Equity (ROE). We’ll use ROE to examine ECI Technology Holdings Limited (

HKG:8013

), by way of a worked example.

ECI Technology Holdings has a ROE of 2.2%

, based on the last twelve months. That means that for every HK$1 worth of shareholders’ equity, it generated HK$0.022 in profit.

View our latest analysis for ECI Technology Holdings

How Do I Calculate Return On Equity?

The

formula for return on equity

is:

Return on Equity = Net Profit ÷ Shareholders’ Equity

Or for ECI Technology Holdings:

2.2% = 1.124 ÷ HK$52m (Based on the trailing twelve months to August 2018.)

Most know that net profit is the total earnings after all expenses, but the concept of shareholders’ equity is a little more complicated. It is all the money paid into the company from shareholders, plus any earnings retained. You can calculate shareholders’ equity by subtracting the company’s total liabilities from its total assets.

What Does Return On Equity Signify?

ROE looks at the amount a company earns relative to the money it has kept within the business. 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 ECI Technology Holdings Have A Good Return On Equity?

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, ECI Technology Holdings has a lower ROE than the average (11%) in the Commercial Services industry classification.

SEHK:8013 Last Perf January 2nd 19

That’s not what we like to see. It is better when the ROE is above industry average, but a low one doesn’t necessarily mean the business is overpriced. Still,

shareholders might want to check if insiders have been selling

.

How Does Debt Impact ROE?

Virtually all companies need money to invest in the business, to grow profits. That cash can come from issuing shares, retained earnings, or debt. In the first and second cases, the ROE will reflect this use of cash for investment in the business. In the latter case, the debt used for growth will improve returns, but won’t affect the total equity. Thus the use of debt can improve ROE, albeit along with extra risk in the case of stormy weather, metaphorically speaking.

Story continues

Combining ECI Technology Holdings’s Debt And Its 2.2% Return On Equity

Although ECI Technology Holdings does use debt, its debt to equity ratio of 0.15 is still low. Its ROE is quite low, and the company already has some debt, so surely shareholders are hoping for an improvement. Conservative use of debt to boost returns is usually a good move for shareholders, though it does leave the company more exposed to interest rate rises.

The Bottom Line On ROE

Return on equity is useful for comparing the quality of different businesses. Companies that can achieve high returns on equity without too much debt are generally of good quality. All else being equal, a higher ROE is better.

But when a business is high quality, the market often bids it up to a price that reflects this. The rate at which profits are likely to grow, relative to the expectations of profit growth reflected in the current price, must be considered, too. You can see how the company has grow in the past by looking at this FREE

detailed graph

of past earnings, revenue and cash flow

.

Of course,

you might find a fantastic investment by looking elsewhere.

So take a peek at this

free

list of interesting companies.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at

[email protected]

.

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