Yahoo Finance What is Behind China Mobile Limited’s (HKG:941) Superior ROE?
One of the best investments we can make is in our own knowledge and skill set. With that in mind, this article will work through how we can use Return On Equity (ROE) to better understand a business. By way of learning-by-doing, we’ll look at ROE to gain a better understanding China Mobile Limited (HKG:941).
Over the last twelve months China Mobile has recorded a ROE of 11%. That means that for every HK$1 worth of shareholders’ equity, it generated HK$0.11 in profit.
View our latest analysis for China Mobile
How Do I Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit ÷ Shareholders’ Equity
Or for China Mobile:
11% = CN¥117.2b ÷ CN¥1.0t (Based on the trailing twelve months to June 2018.)
Most readers would understand what net profit is, but it’s worth explaining the concept of shareholders’ equity. It is all earnings retained by the company, plus any capital paid in by shareholders. You can calculate shareholders’ equity by subtracting the company’s total liabilities from its total assets.
What Does ROE Signify?
ROE looks at the amount a company earns relative to the money it has kept within the business. The ‘return’ is the yearly profit. The higher the ROE, the more profit the company is making. So, all else being equal, a high ROE is better than a low one. That means it can be interesting to compare the ROE of different companies.
Does China Mobile Have A Good ROE?
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. The image below shows that China Mobile has an ROE that is roughly in line with the wireless telecom industry average (9.9%).
That isn’t amazing, but it is respectable. Of course, this year’s ROE might be a product of last year’s decisions. So I like to check the tenure of the board and CEO, before reaching any conclusions.
How Does Debt Impact Return On Equity?
Virtually all companies need money to invest in the business, to grow profits. That cash can come from retained earnings, issuing new shares (equity), 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. That will make the ROE look better than if no debt was used.
China Mobile’s Debt And Its 11% ROE
China Mobile is free of net debt, which is a positive for shareholders. Its ROE already suggests it is a good business, but the fact it has achieved this — and doesn’t borrowings — makes it worthy of further consideration, in my view. After all, when a company has a strong balance sheet, it can often find ways to invest in growth, even if it takes some time.
In Summary
Return on equity is a useful indicator of the ability of a business to generate profits and return them to shareholders. A company that can achieve a high return on equity without debt could be considered a high quality business. If two companies have around the same level of debt to equity, and one has a higher ROE, I’d 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. It is important to consider other factors, such as future profit growth — and how much investment is required going forward. So you might want to take a peek at this data-rich interactive graph of forecasts for the company.
Of course China Mobile 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.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
