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 Swiss Life Holding AG (VTX:SLHN), by way of a worked example.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder’s equity.
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The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders’ Equity
So, based on the above formula, the ROE for Swiss Life Holding is:
16% = CHF1.3b ÷ CHF7.7b (Based on the trailing twelve months to December 2024).
The ‘return’ is the profit over the last twelve months. That means that for every CHF1 worth of shareholders’ equity, the company generated CHF0.16 in profit.
Check out our latest analysis for Swiss Life Holding
By comparing a company’s ROE with its industry average, we can get a quick measure of how good it is. The limitation of this approach is that some companies are quite different from others, even within the same industry classification. As you can see in the graphic below, Swiss Life Holding has a higher ROE than the average (13%) in the Insurance industry.
That’s what we like to see. Bear in mind, a high ROE doesn’t always mean superior financial performance. Especially when a firm uses high levels of debt to finance its debt which may boost its ROE but the high leverage puts the company at risk.
Companies usually need to invest money to grow their profits. The cash for investment can come from prior year profits (retained earnings), issuing new shares, or borrowing. In the case of the first and second options, the ROE will reflect this use of cash, for growth. In the latter case, the debt required for growth will boost returns, but will not impact the shareholders’ equity. In this manner the use of debt will boost ROE, even though the core economics of the business stay the same.
Swiss Life Holding does use a high amount of debt to increase returns. It has a debt to equity ratio of 1.91. While its ROE is respectable, it is worth keeping in mind that there is usually a limit as to how much debt a company can use. Debt does bring extra risk, so it’s only really worthwhile when a company generates some decent returns from it.