While some investors are already well versed in financial metrics (hat tip), this article is for those who would like to learn about Return On Equity (ROE) and why it is important. Well use ROE to examine Genetics Generation Advancement Corp. (GTSM:4160), by way of a worked example.

Our data shows Genetics Generation Advancement has a return on equity of 5.7% for the last year. One way to conceptualize this, is that for each NT$1 of shareholders equity it has, the company made NT$0.06 in profit.

Check out our latest analysis for Genetics Generation Advancement

The formula for return on equity is:

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

Or for Genetics Generation Advancement:

5.7% = NT$20m NT$352m (Based on the trailing twelve months to September 2019.)

Its easy to understand the net profit part of that equation, but shareholders equity requires further explanation. It is all earnings retained by the company, plus any capital paid in by shareholders. You can calculate shareholders equity by subtracting the companys total liabilities from its total assets.

ROE looks at the amount a company earns relative to the money it has kept within the business. The return is the profit over the last twelve months. That means that the higher the ROE, the more profitable the company is. So, all else being equal, a high ROE is better than a low one. Clearly, then, one can use ROE to compare different companies.

One simple way to determine if a company has a good return on equity is to compare it to the average for its industry. Importantly, this is far from a perfect measure, because companies differ significantly within the same industry classification. The image below shows that Genetics Generation Advancement has an ROE that is roughly in line with the Biotechs industry average (5.7%).

That isnt amazing, but it is respectable. ROE doesnt tell us if the share price is low, but it can inform us to the nature of the business. For those looking for a bargain, other factors may be more important. If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

Companies usually need to invest money to grow their profits. The cash for investment can come from prior year profits (retained earnings), issuing new shares, or 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 the returns, but will not change the equity. Thus the use of debt can improve ROE, albeit along with extra risk in the case of stormy weather, metaphorically speaking.

Shareholders will be pleased to learn that Genetics Generation Advancement has not one iota of net debt! So although its ROE isnt that impressive, we shouldnt judge it harshly on that metric, because it didnt use debt. After all, with cash on the balance sheet, a company has a lot more optionality in good times and bad.

Return on equity is one way we can compare the business quality of different companies. In my book the highest quality companies have high return on equity, despite low debt. If two companies have around the same level of debt to equity, and one has a higher ROE, Id generally prefer the one with higher ROE.

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. Check the past profit growth by Genetics Generation Advancement by looking at this visualization of past earnings, revenue and cash flow.

Of course Genetics Generation Advancement may not be the best stock to buy. So you may wish to see this free collection of other companies that have high ROE and low debt.

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.

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. Thank you for reading.

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A Note On Genetics Generation Advancement Corp.s (GTSM:4160) ROE and Debt To Equity - Simply Wall St