Wednesday, June 29 2022

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. Learning by doing, we will look at ROE to better understand Ubisoft Entertainment SA (EPA:UBI).

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 short, ROE shows the profit that each dollar generates in relation to the investments of its shareholders.

Check out our latest analysis for Ubisoft Entertainment

How do you calculate return on equity?

the return on equity formula is:

Return on equity = Net income (from continuing operations) ÷ Equity

So, based on the formula above, the ROE for Ubisoft Entertainment is:

4.8% = €85M ÷ €1.8B (based on the last twelve months until September 2021).

“Yield” refers to a company’s earnings over the past year. Another way to think about this is that for every $1 of equity, the company was able to make $0.05 in profit.

Does Ubisoft Entertainment have a good ROE?

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 quite different from others, even within the same industrial classification. As shown in the graph below, Ubisoft Entertainment has a lower than average ROE (6.9%) of the entertainment industry ranking.

ENXTPA:UBI Return on Equity May 1, 2022

Unfortunately, this is suboptimal. However, we believe that a lower ROE could still mean that a company has the opportunity to improve its returns through the use of leverage, provided its existing debt levels are low. A highly leveraged company with a low ROE is a whole other story and a risky investment on our books.

Why You Should Consider Debt When Looking at ROE

Companies generally need to invest money to increase their profits. The money for the investment can come from the previous year’s earnings (retained earnings), from issuing new shares or from borrowing. 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 returns, but will not change equity. This will make the ROE better than if no debt was used.

Combine Ubisoft Entertainment’s debt and its 4.8% return on equity

Ubisoft Entertainment is clearly using a high amount of debt to boost returns, as it has a debt ratio of 1.00. Its ROE is quite low, even with the use of significant debt; this is not a good result, in our view. Debt increases risk and reduces options for the business in the future, so you generally want to see good returns using it.

Conclusion

Return on equity is useful for comparing the quality of different companies. 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 roughly the same level of debt and one has a higher ROE, I generally prefer the one with a higher ROE.

That said, while ROE is a useful indicator of a company’s quality, you’ll need to consider a whole host of factors to determine the right price to buy a stock. Earnings growth rates, relative to expectations reflected in the share price, are particularly important to consider. So I think it’s worth checking it out free analyst forecast report for the company.

But note: Ubisoft Entertainment may not be the best stock to buy. So take a look at this free list of interesting companies with high ROE and low debt.

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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