Can debt increase the company's EPS and ROE
Return on equity
The so-called return on equity, also under the English term "Return on Equity" (abbreviated: ROE) is known, ultimately describes the Interest on the owner's equity. "Return on Equity" is nothing more than a pure return on capital for your own company and indicates how many percentage points profit fromEquitywere achieved. Most of all the last fiscal year taken into consideration. This metric is often used to Valuation of a company used. It should be noted, however, that the return on equity - depending on the industry - entails enormous deviations and can be diluted by other factors.
Importance of Return on Equity
"Return on Equity" or ROE has become more and more popular for the term return on equity. Both terms sound different but mean the same thing. The American major investor and inventor of the so-called value investment attaches great importance to the ratio of the return on equity in his analyzes. In his opinion, a good ROE should be the basis for an extremely successful investment in stocks or companies.
Calculation of the ROE
The return on equity can be calculated on the basis of Company profit for the year Calculate by dividing this by the capital employed.
Example: If a company has around 100 million euros and at the same time makes an annual profit of 5 million euros, the return on equity is 5 percent. In the business world, 10 to 15% return on equity is seen as a sign of a healthy and efficient company. However, the assessment should be differentiated and compared with other key figures.
There are industry-specific differences
If there is a high return on equity, this is considered a positive sign for the Efficiency and profitability of a company rated. However, one must take into account that there are industry-specific differences that can affect the ROE. For example, if you have a very high capital investment, but have a lot of employees - so you have to bear high personnel costs - and at the same time only achieve a low profit margin, you will sometimes have a low return, although the company was very successful with it.
However, if it is a company that has a very low cost structure and little equity, a significantly higher return on equity can be achieved and the company can look better on paper than it is the truth.
How do you recognize an efficient company?
Even if there are industry-specific differences, the Rule of thumb It should be noted that the return on equity should be at least as high as the interest rate that is currently given on the capital market. However, if the rate of return falls below the interest rate on capital, the money could well be invested in the capital market, as this is more profitable.
The leverage effect
Another point that sometimes distorts the calculation is the so-called Leverage effect. Since the return on equity is only calculated on the basis of the equity used, additionally recordedBorrowed capital achieve an improvement in the ratio. Because thanks to the outside capital, an increase in profit is possible - the equity, however, remains constant. The leverage effect thus ensures a Increase in return on equity.
Note “hidden reserves”
Today that counts Return on equity to the most important economic key figures, if the profitability of the company is to be calculated or measured. Similar to the leverage effect, “hidden reserves” can also distort the overall picture. So the entrepreneur always has access to his hidden reserves ”- There are seldom increases in profits, since only the own reserves were used.
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