Advertisement
New Zealand markets closed
  • NZX 50

    12,105.29
    +94.63 (+0.79%)
     
  • NZD/USD

    0.5981
    -0.0025 (-0.41%)
     
  • NZD/EUR

    0.5529
    -0.0014 (-0.25%)
     
  • ALL ORDS

    8,153.70
    +80.10 (+0.99%)
     
  • ASX 200

    7,896.90
    +77.30 (+0.99%)
     
  • OIL

    82.38
    +1.03 (+1.27%)
     
  • GOLD

    2,228.60
    +15.90 (+0.72%)
     
  • NASDAQ

    18,290.31
    +9.47 (+0.05%)
     
  • FTSE

    7,966.34
    +34.36 (+0.43%)
     
  • Dow Jones

    39,768.45
    +8.37 (+0.02%)
     
  • DAX

    18,497.50
    +20.41 (+0.11%)
     
  • Hang Seng

    16,541.42
    +148.58 (+0.91%)
     
  • NIKKEI 225

    40,168.07
    -594.66 (-1.46%)
     
  • NZD/JPY

    90.4100
    -0.3700 (-0.41%)
     

Spirax-Sarco Engineering plc (LON:SPX) Delivered A Better ROE Than Its Industry

Want to participate in a research study? Help shape the future of investing tools and earn a $60 gift card!

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 Spirax-Sarco Engineering plc (LON:SPX), by way of a worked example.

Over the last twelve months Spirax-Sarco Engineering has recorded a ROE of 29%. One way to conceptualize this, is that for each £1 of shareholders' equity it has, the company made £0.29 in profit.

View our latest analysis for Spirax-Sarco Engineering

How Do I Calculate ROE?

The formula for return on equity is:

ADVERTISEMENT

Return on Equity = Net Profit ÷ Shareholders' Equity

Or for Spirax-Sarco Engineering:

29% = UK£223m ÷ UK£767m (Based on the trailing twelve months to December 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. You can calculate shareholders' equity by subtracting the company's total liabilities from its total assets.

What Does Return On Equity Signify?

ROE measures a company's profitability against the profit it retains, and any outside investments. The 'return' is the profit over the last twelve months. That means that the higher the ROE, the more profitable the company is. So, as a general rule, a high ROE is a good thing. That means ROE can be used to compare two businesses.

Does Spirax-Sarco Engineering Have A Good Return On Equity?

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 you can see in the graphic below, Spirax-Sarco Engineering has a higher ROE than the average (12%) in the Machinery industry.

LSE:SPX Past Revenue and Net Income, March 28th 2019
LSE:SPX Past Revenue and Net Income, March 28th 2019

That's clearly a positive. 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 ROE?

Companies usually need to invest money to grow their profits. That cash can come from retained earnings, issuing new shares (equity), or debt. In the case of the first and second options, the ROE will reflect this use of cash, for growth. In the latter case, the use of debt will improve the returns, but will not change the equity. That will make the ROE look better than if no debt was used.

Combining Spirax-Sarco Engineering's Debt And Its 29% Return On Equity

Spirax-Sarco Engineering has a debt to equity ratio of 0.55, which is far from excessive. Its ROE is very impressive, and given only modest debt, this suggests the business is high quality. Careful use of debt to boost returns is often very good for shareholders. However, it could reduce the company's ability to take advantage of future opportunities.

In Summary

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. If two companies have around the same level of debt to equity, and one has a higher ROE, I'd generally prefer the one with higher ROE.

But when a business is high quality, the market often bids it up to a price that reflects this. Profit growth rates, versus the expectations reflected in the price of the stock, are a particularly important to consider. So you might want to check this FREE visualization of analyst forecasts for the company.

But note: Spirax-Sarco Engineering 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.

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.

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. Thank you for reading.