A note on the ROE and debt on equity of Poste Italiane SpA (BIT: PST)

One of the best investments we can make is in our own knowledge and skills. With that in mind, this article will discuss how we can use Return on Equity (ROE) to better understand a business. We will use ROE to examine Poste Italiane SpA (BIT: PST), through a worked example.

ROE or return on equity is a useful tool to assess how effectively a company can generate the returns on investment it has received from its shareholders. In other words, it is a profitability ratio that measures the rate of return on capital contributed by the shareholders of the company.

See our latest analysis for Poste Italiane

How to calculate return on equity?

ROE can be calculated using the formula:

Return on equity = Net income (from continuing operations) ÷ Equity

Thus, based on the above formula, Poste Italiane’s ROE is:

12% = 1.5 billion euros ÷ 13 billion euros (based on the last twelve months up to September 2021).

The “return” is the annual profit. One way to conceptualize this is that for every € 1 of share capital it has, the company has made € 0.12 in profit.

Does La Poste Italiane have a good ROE?

Perhaps the easiest way to assess a company’s ROE is to compare it to the industry average. The limitation of this approach is that some companies are very different from others, even within the same industry classification. You can see in the graph below that Poste Italiane has a ROE quite close to the insurance industry average (11%).

BIT: PST Return on Equity December 25, 2021

So even if the ROE is not exceptional, it is at least acceptable. Even though the ROE is respectable compared to the industry, it is worth checking out if the company’s ROE is helped by high debt levels. If a business is too indebted, it runs a higher risk of defaulting on interest. Our risk dashboard should include the 3 risks that we have identified for Poste Italiane.

What is the impact of debt on return on equity?

Almost all businesses need money to invest in the business, to increase their profits. This liquidity can come from retained earnings, the issuance of new shares (equity) or debt. In the case of the first and second options, the ROE will reflect this use of cash, for growth. In the latter case, the debt used for growth will improve returns, but will not affect total equity. This will make the ROE better than if no debt was used.

Poste Italiane’s debt and its 12% ROE

It appears that Poste Italiane relies heavily on leverage to improve its returns, as its debt-to-equity ratio is alarmingly high at 7.70. The combination of a rather low ROE and a high debt ratio is negative, in our book.

Conclusion

Return on equity is useful for comparing the quality of different companies. In our books, the highest quality companies have a high return on equity, despite low leverage. All other things being equal, a higher ROE is preferable.

But ROE is only one piece of a bigger puzzle, as high-quality companies often trade at high earnings multiples. The rate at which earnings are likely to grow, relative to earnings growth expectations reflected in the current price, should also be taken into account. So you might want to check out this FREE visualization of analyst forecasts for the business.

But beware : Poste Italiane may not be the best stock to buy. So take a look at this free list of interesting companies with high ROE and low debt.

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


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John A. Bogar