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). We'll use ROE to examine Electrovaya Inc. (TSE:ELVA), by way of a worked example.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Electrovaya

How Is ROE Calculated?

The formula for return on equity is:

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

So, based on the above formula, the ROE for Electrovaya is:

7.8% = US$592k ÷ US$7.6m (Based on the trailing twelve months to June 2024).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each CA$1 of shareholders' capital it has, the company made CA$0.08 in profit.

Does Electrovaya 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. Importantly, this is far from a perfect measure, because companies differ significantly within the same industry classification. As is clear from the image below, Electrovaya has a lower ROE than the average (12%) in the Electrical industry.

Unfortunately, that's sub-optimal. That being said, a low ROE is not always a bad thing, especially if the company has low leverage as this still leaves room for improvement if the company were to take on more debt. A company with high debt levels and low ROE is a combination we like to avoid given the risk involved. Our risks dashboard should have the 3 risks we have identified for Electrovaya.

How Does Debt Impact Return On Equity?

Most companies need money -- from somewhere -- to grow their 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 Electrovaya's Debt And Its 7.8% Return On Equity

Electrovaya clearly uses a high amount of debt to boost returns, as it has a debt to equity ratio of 2.38. The combination of a rather low ROE and significant use of debt is not particularly appealing. Debt does bring extra risk, so it's only really worthwhile when a company generates some decent returns from it.