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. We'll use ROE to examine Dalrymple Bay Infrastructure Limited (ASX:DBI), 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.

See our latest analysis for Dalrymple Bay Infrastructure

The formula for ROE is:

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

So, based on the above formula, the ROE for Dalrymple Bay Infrastructure is:

6.9% = AU$77m ÷ AU$1.1b (Based on the trailing twelve months to June 2024).

The 'return' is the amount earned after tax over the last twelve months. That means that for every A$1 worth of shareholders' equity, the company generated A$0.07 in profit.

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. You can see in the graphic below that Dalrymple Bay Infrastructure has an ROE that is fairly close to the average for the Infrastructure industry (6.9%).

That's neither particularly good, nor bad. Although the ROE is similar to the industry, we should still perform further checks to see if the company's ROE is being boosted by high debt levels. If so, this increases its exposure to financial risk. To know the 2 risks we have identified for Dalrymple Bay Infrastructure visit our risks dashboard for free.

Companies usually need to invest money to grow their profits. That cash can come from issuing shares, retained earnings, or debt. In the first two cases, the ROE will capture this use of capital to grow. In the latter case, the debt used for growth will improve returns, but won't affect the total equity. That will make the ROE look better than if no debt was used.

It's worth noting the high use of debt by Dalrymple Bay Infrastructure, leading to its debt to equity ratio of 2.25. With a fairly low ROE, and significant use of debt, it's hard to get excited about this business at the moment. Investors should think carefully about how a company might perform if it was unable to borrow so easily, because credit markets do change over time.