Should You Be Worried About Fanli Digital Technology Co.,Ltd's (SHSE:600228) 4.4% Return On Equity?

Simply Wall St · Oct 30, 2023 20:04

Many investors are still learning about the various metrics that can be useful when analysing a stock. This article is for those who would like to learn about Return On Equity (ROE). To keep the lesson grounded in practicality, we'll use ROE to better understand Fanli Digital Technology Co.,Ltd (SHSE:600228).

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Fanli Digital TechnologyLtd

How To Calculate Return On Equity?

The formula for ROE is:

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

So, based on the above formula, the ROE for Fanli Digital TechnologyLtd is:

4.4% = CN¥49m ÷ CN¥1.1b (Based on the trailing twelve months to June 2023).

The 'return' is the yearly profit. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.04 in profit.

Does Fanli Digital TechnologyLtd Have A Good Return On Equity?

Arguably the easiest way to assess company's ROE is to compare it with the average in its industry. However, this method is only useful as a rough check, because companies do differ quite a bit within the same industry classification. As shown in the graphic below, Fanli Digital TechnologyLtd has a lower ROE than the average (7.0%) in the Interactive Media and Services industry classification.

roe — SHSE:600228 Return on Equity October 31st 2023

That's not what we like to see. However, a low ROE is not always bad. If the company's debt levels are moderate to low, then there's still a chance that returns can be improved via the use of financial leverage. A high debt company having a low ROE is a different story altogether and a risky investment in our books.

The Importance Of Debt To Return On Equity

Virtually all companies need money to invest in the business, to grow profits. That cash can come from issuing shares, retained earnings, or debt. In the first and second cases, the ROE will reflect this use of cash for investment in the business. In the latter case, the debt required for growth will boost returns, but will not impact the shareholders' equity. Thus the use of debt can improve ROE, albeit along with extra risk in the case of stormy weather, metaphorically speaking.

Combining Fanli Digital TechnologyLtd's Debt And Its 4.4% Return On Equity

One positive for shareholders is that Fanli Digital TechnologyLtd does not have any net debt! Without a doubt it has a fairly low ROE, but that isn't so bad when you consider it has no debt. After all, with cash on the balance sheet, a company has a lot more optionality in good times and bad.

Summary

Return on equity is one way we can compare its business quality of different companies. A company that can achieve a high return on equity without debt could be considered a high quality business. All else being equal, a higher ROE is better.

But ROE is just one piece of a bigger puzzle, since high quality businesses often trade on high multiples of earnings. The rate at which profits are likely to grow, relative to the expectations of profit growth reflected in the current price, must be considered, too. Check the past profit growth by Fanli Digital TechnologyLtd by looking at this visualization of past earnings, revenue and cash flow.

But note: Fanli Digital TechnologyLtd may not be the best stock to buy. So take a peek at this free list of interesting companies with high ROE and low debt.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an 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 account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.