Profit ratio

Can the ROE of Taste Gourmet Group Limited (HKG:8371) continue to outperform the industry average?

One of the best investments we can make is in our own knowledge and skills. With that in mind, this article will explain how we can use return on equity (ROE) to better understand a business. We’ll use ROE to look at Taste Gourmet Group Limited (HKG:8371), as a working example.

Return on equity or ROE is a key metric used to gauge how effectively a company’s management is using the company’s capital. In other words, it is a profitability ratio that measures the rate of return on capital contributed by the company’s shareholders.

Check out our latest analysis for Taste Gourmet Group

How to calculate return on equity?

the ROE formula is:

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

So, based on the above formula, the ROE for Taste Gourmet Group is:

29% = HK$49 million ÷ HK$168 million (based on trailing 12 months to December 2021).

The “yield” is the profit of the last twelve months. So this means that for every HK$1 investment of its shareholder, the company generates a profit of HK$0.29.

Does Taste Gourmet Group have a good ROE?

Perhaps the easiest way to assess a company’s ROE is to compare it to the industry average. However, this method is only useful as a rough check, as companies differ quite a bit within the same industry classification. As the image below clearly shows, Taste Gourmet Group has a better ROE than the average (4.8%) for the hospitality industry.

SEHK:8371 Return on Equity May 11, 2022

This is clearly a positive point. However, keep in mind that a high ROE does not necessarily indicate efficient profit generation. Especially when a company uses high levels of debt to finance its debt, which can increase its ROE, but the high leverage puts the company at risk. To learn about the 5 risks we have identified for Taste Gourmet Group, visit our risk dashboard for free.

The Importance of Debt to Return on Equity

Virtually all businesses need money to invest in the business, to increase their profits. This money can come from issuing shares, retained earnings or debt. In the first and second case, the ROE will reflect this use of cash for investment in the business. In the latter case, the use of debt will improve returns, but will not change equity. In this way, the use of debt will increase ROE, even though the core economics of the business remains the same.

The debt of the Taste Gourmet Group and its ROE of 29%

Taste Gourmet Group uses a high amount of debt to increase returns. Its debt to equity ratio is 1.68. While there is no doubt that its ROE is impressive, we would have been even more impressed if the company had achieved this with less debt. Investors need to think carefully about how a company would perform if it weren’t able to borrow so easily, as credit markets change over time.

Conclusion

Return on equity is a way to compare the business quality of different companies. In our books, the highest quality companies have a high return on equity, despite low leverage. If two companies have the same ROE, I would generally prefer the one with less debt.

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 this detailed graph past profits, revenue and cash flow.

If you’d rather check out another company – one with potentially superior finances – then don’t miss this free list of attractive companies, which have a high return on equity 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.