T
his article is for investors who want to learn about Return On Equity (ROE) and its significance. We'll use Fundamenta Real Estate AG as a case study to understand ROE better.

    Return on equity measures how efficiently a company's management uses the company's capital. It assesses a company's profitability in relation to its equity capital. To calculate ROE, you divide net profit by shareholders' equity. For Fundamenta Real Estate, this results in an ROE of 6.0% (CHF30m ÷ CHF512m) based on the trailing twelve months to December 2024.

    The 'return' represents yearly profit. In simpler terms, for every CHF1 worth of equity, the company earns CHF0.06 in profit. By comparing a company's ROE with its industry average, you can gauge how good it is. However, this method has limitations as companies within the same industry classification differ significantly.

    Fundamenta Real Estate's ROE (6.0%) is close to the average for the Real Estate industry (7.2%). While this isn't particularly impressive or disappointing, it's worth checking if the firm's ROE is being aided by high debt levels. If so, this increases its exposure to financial risk.

    Most companies use cash from retained earnings, issuing new shares, or debt to grow their profits. In cases where the first two options are used, the ROE reflects this use of cash for growth. However, when debt is used for growth, it improves returns without affecting total equity. Fundamenta Real Estate uses a high amount of debt to increase returns, with a debt-to-equity ratio of 1.29.

    Given its fairly low ROE and significant debt usage, it's challenging to be enthusiastic about this business at the moment. Debt increases risk and reduces options for the company in the future, so you generally want to see good returns from using it.