With a return on equity of 1.4%, is Tera Light Ltd (TLV: TRLT) a quality stock?
While some investors are already familiar with financial metrics (hat tip), this article is for those who want to learn more about return on equity (ROE) and why it is important. We will use ROE to examine Tera Light Ltd (TLV: TRLT), through a worked example.
Return on equity or ROE is an important factor for a shareholder to consider, as it tells them how effectively their capital is being reinvested. In other words, it is a profitability ratio that measures the rate of return on capital contributed by the shareholders of the company.
Check out our latest analysis for Tera Light
How is the ROE calculated?
the formula for ROE is:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the above formula, Tera Light’s ROE is:
1.4% = ₪ 3.5m ÷ ₪ 250m (Based on the last twelve months up to June 2021).
The “return” is the annual profit. This therefore means that for each 1 of its shareholder’s investments, the company generates a profit of ₪ 0.01.
Does Tera Light have a good ROE?
Perhaps the easiest way to assess a company’s ROE is to compare it to the industry average. It is important to note that this measure is far from perfect, as companies differ considerably within a single industry classification. As shown in the graph below, Tera Light has a lower than average ROE (9.0%) for the electrical industry classification.
It is certainly not ideal. However, a low ROE is not always bad. If the company’s debt levels are moderate to low, there is still a chance that returns can be improved through the use of financial leverage. When a company has a low ROE but high levels of debt, we would be careful because the risk involved is too high. Our risk dashboard should contain the 3 risks that we have identified for Tera Light.
Why You Should Consider Debt When Looking At ROE
Most businesses need money – from somewhere – to increase their profits. This liquidity can come from the issuance of shares, retained earnings or debt. In the first and second cases, the ROE will reflect this use of cash for investing in the business. In the latter case, the use of debt will improve returns, but will not affect equity. This will make the ROE better than if no debt was used.
Combine Tera Light’s debt and its 1.4% return on equity
Although Tera Light uses quite a bit of debt, its debt-to-equity ratio of just 0.00005 is very low. His ROE is certainly low, and since he’s already using up debt, we’re not too excited about the business. Using debt wisely to improve returns can certainly be a good thing, even if it slightly increases risk and lowers future option.
Return on equity is a useful indicator of a company’s ability to generate profits and return them to shareholders. A business that can earn a high return on equity without going into debt can be considered a high quality business. If two companies have the same ROE, I would generally prefer the one with the least amount of debt.
But when a company is of high quality, the market often offers it up to a price that reflects that. It is important to take into account other factors, such as future profit growth and the amount of investment required for the future. You can see how the business has grown in the past by checking out this FREE detailed graphic past earnings, income and cash flow.
But beware : Tera Light might not be the best stock to buy. So take a look at this free list of interesting companies with high ROE and low debt.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only 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 into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.