I
nvestors often struggle to understand the various metrics used in stock analysis. This article aims to explain Return On Equity (ROE) and demonstrate its application through a worked example using Novavest Real Estate AG (VTX:NREN). ROE measures a company's ability to grow value and manage investors' money by assessing profitability relative to shareholder equity.

    To calculate ROE, use the formula: ROE = Net Profit ÷ Shareholders' Equity. For Novavest Real Estate, this results in an ROE of 4.5% (CHF19m ÷ CHF423m) based on trailing twelve months data to December 2024. This means that for every CHF1 invested by shareholders, the company generates a profit of CHF0.05.

    Comparing ROE to industry averages can be a useful starting point, but it's essential to consider individual company differences within an industry classification. Novavest Real Estate has a lower ROE (4.5%) than the average in its Real Estate industry classification (6.5%). While a low ROE isn't always a cause for concern, especially if leverage is low, high debt levels can increase risk.

    Companies often use retained earnings, new shares, or debt to grow profits. In cases where debt is used, the ROE will capture this capital growth, but it won't change the equity. Novavest Real Estate has a high debt-to-equity ratio of 1.32 and a low ROE, even with significant debt use. This suggests that investors should consider how the company might perform if credit markets changed or borrowing became more difficult.