Australia markets open in 1 hour 52 minutes
  • ALL ORDS

    7,587.40
    +24.90 (+0.33%)
     
  • AUD/USD

    0.7130
    -0.0012 (-0.17%)
     
  • ASX 200

    7,256.00
    +16.20 (+0.22%)
     
  • OIL

    66.64
    -3.31 (-4.73%)
     
  • GOLD

    1,773.90
    -11.30 (-0.63%)
     
  • BTC-AUD

    80,845.25
    -1,143.57 (-1.39%)
     
  • CMC Crypto 200

    1,471.31
    +28.53 (+1.98%)
     

A Closer Look At AFT Pharmaceuticals Limited's (NZSE:AFT) Impressive ROE

  • Oops!
    Something went wrong.
    Please try again later.
·3-min read
In this article:
  • Oops!
    Something went wrong.
    Please try again later.

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). To keep the lesson grounded in practicality, we'll use ROE to better understand AFT Pharmaceuticals Limited (NZSE:AFT).

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for AFT Pharmaceuticals

How Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for AFT Pharmaceuticals is:

21% = NZ$7.8m ÷ NZ$37m (Based on the trailing twelve months to March 2021).

The 'return' refers to a company's earnings over the last year. That means that for every NZ$1 worth of shareholders' equity, the company generated NZ$0.21 in profit.

Does AFT Pharmaceuticals Have A Good Return On Equity?

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 is clear from the image below, AFT Pharmaceuticals has a better ROE than the average (16%) in the Pharmaceuticals industry.

roe
roe

That's clearly a positive. However, bear in mind that a high ROE doesn’t necessarily indicate efficient profit generation. 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. You can see the 3 risks we have identified for AFT Pharmaceuticals by visiting our risks dashboard for free on our platform here.

How Does Debt Impact Return On Equity?

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 debt used for growth will improve returns, but won't affect the total equity. That will make the ROE look better than if no debt was used.

AFT Pharmaceuticals' Debt And Its 21% ROE

AFT Pharmaceuticals clearly uses a high amount of debt to boost returns, as it has a debt to equity ratio of 1.05. There's no doubt its ROE is decent, but the very high debt the company carries is not too exciting to see. 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.

Summary

Return on equity is a useful indicator of the ability of a business to generate profits and return them to shareholders. A company that can achieve a high return on equity without debt could be considered a high quality business. If two companies have the same ROE, then I would generally prefer the one with less debt.

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. So you might want to check this FREE visualization of analyst forecasts for the company.

If you would prefer check out another company -- one with potentially superior financials -- then do not miss this free list of interesting companies, that have HIGH return on equity and low debt.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

Our goal is to create a safe and engaging place for users to connect over interests and passions. In order to improve our community experience, we are temporarily suspending article commenting