【starter engages but doesn't spin】Is China Shanshui Cement Group Limited (HKG:691) A High Quality Stock To Own?
One of the best investments we can make is starter engages but doesn't spinin 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. By way of learning-by-doing, we’ll look at ROE to gain a better understanding of China Shanshui Cement Group Limited (
HKG:691
).
Over the last twelve months
China Shanshui Cement Group has recorded a ROE of 29%
. Another way to think of that is that for every HK$1 worth of equity in the company, it was able to earn HK$0.29.
See our latest analysis for China Shanshui Cement Group
How Do I Calculate ROE?
The
formula for return on equity
is:
Return on Equity = Net Profit ÷ Shareholders’ Equity
Or for China Shanshui Cement Group:
29% = 1396.278 ÷ CN¥4.7b (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 the capital paid in by shareholders, plus any retained earnings. The easiest way to calculate shareholders’ equity is to subtract the company’s total liabilities from the total assets.
What Does ROE Mean?
ROE looks at the amount a company earns relative to the money it has kept within the business. The ‘return’ is the profit over the last twelve months. That means that the higher the ROE, the more profitable the company is. So, all else equal,
investors should like a high ROE
. Clearly, then, one can use ROE to compare different companies.
Does China Shanshui Cement Group Have A Good ROE?
One 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 quite different from others, even within the same industry classification. As is clear from the image below, China Shanshui Cement Group has a better ROE than the average (11%) in the Basic Materials industry.
SEHK:691 Last Perf January 2nd 19
That’s what I like to see. We think a high ROE, alone, is usually enough to justify further research into a company. For example,
I often check if insiders have been buying shares
.
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 and second cases, the ROE will reflect this use of cash for investment in the business. In the latter case, the debt required for growth will boost returns, but will not impact the shareholders’ equity. That will make the ROE look better than if no debt was used.
Story continues
China Shanshui Cement Group’s Debt And Its 29% ROE
China Shanshui Cement Group clearly uses a significant amount debt to boost returns, as it has a debt to equity ratio of 2.81. I think the ROE is impressive, but it would have been assisted by the use of 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 one way we can compare the business quality of different companies. 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 ROE is just one piece of a bigger puzzle, since high quality businesses often trade on high multiples of earnings. Profit growth rates, versus the expectations reflected in the price of the stock, are a particularly important to consider. Check the past profit growth by China Shanshui Cement Group by looking at this
visualization of past earnings, revenue and cash flow
.
But note:
China Shanshui Cement Group may not be the best stock to buy
. So take a peek at this
free
list of interesting companies with high ROE and low debt.
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
.
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