Should you be excited about the 31% return on equity of WAG payment solutions plc (LON:WPS)?

While some investors are already familiar with financial metrics (hat trick), this article is for those who want to learn more about return on equity (ROE) and why it matters. As a learning-by-doing, we will look at ROE to better understand WAG plc (LON:WPS) payment solutions.

Return on equity or ROE is a key metric used to gauge how effectively a company’s management is using the company’s capital. In other words, it reveals the company’s success in turning shareholders’ investments into profits.

Discover our latest analysis of WAG payment solutions

How do you calculate return on equity?

ROE can be calculated using the formula:

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

So, based on the above formula, the ROE for WAG payment solutions is:

31% = €23m ÷ €74m (based on the last twelve months to June 2021).

The “return” is the annual profit. One way to conceptualize this is that for every pound of share capital it has, the company has made a profit of 0.31 pounds.

Do WAG payment solutions have a good return on equity?

A simple way to determine if a company has a good return on equity is to compare it to the average for its industry. The limitation of this approach is that some companies are very different from others, even within the same industrial classification. Fortunately, WAG payment solutions have an ROE above the IT industry average (12%).

LSE: WPS Return on Equity January 18, 2022

It’s a good sign. That said, a high ROE does not always mean high profitability. Especially when a company uses high levels of debt to finance its debt, which can increase its ROE, but the high leverage puts the company at risk. To learn about the 2 risks we have identified for WAG payment solutions, visit our risk dashboard for free.

What is the impact of debt on return on equity?

Companies generally need to invest money to increase their profits. This money can come from issuing shares, retained earnings or debt. In the first and second case, the ROE will reflect this use of cash for investment in the business. In the latter case, the use of debt will improve returns, but will not change equity. This will make the ROE better than if no debt was used.

The debt of WAG payment solutions and its ROE of 31%

WAG payment solutions clearly use a high amount of leverage to increase returns, as they have a debt-to-equity ratio of 2.54. Its ROE is quite impressive, but it probably would have been lower without the use of debt. Investors need to think carefully about how a company would perform if it weren’t able to borrow so easily, as credit markets change over time.

Conclusion

Return on equity is a useful indicator of a company’s ability to generate profits and return them to shareholders. In our books, the highest quality companies have a high return on equity, despite low leverage. All things being equal, a higher ROE is better.

That said, while ROE is a useful indicator of a company’s quality, you’ll need to consider a whole host of factors to determine the right price to buy a stock. The rate at which earnings are likely to grow, relative to earnings growth expectations reflected in the current price, should also be considered. You might want to check out this FREE analyst forecast visualization for the company.

If you’d rather check out another company – one with potentially superior finances – then don’t miss this free list of attractive companies, which have a high return on equity and low debt.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.


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