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). By way of learning-by-doing, we'll look at ROE to gain a better understanding of Kelso Technologies Inc. (TSE:KLS).

Our data shows Kelso Technologies has a return on equity of 24% for the last year. One way to conceptualize this, is that for each CA$1 of shareholders' equity it has, the company made CA$0.24 in profit.

View our latest analysis for Kelso Technologies

How Do You Calculate ROE?

The formula for ROE is:

Return on Equity = Net Profit ÷ Shareholders' Equity

Or for Kelso Technologies:

24% = US$2.5m ÷ US$10m (Based on the trailing twelve months to September 2019.)

It's easy to understand the 'net profit' part of that equation, but 'shareholders' equity' requires further explanation. 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 Return On Equity Mean?

ROE looks at the amount a company earns relative to the money it has kept within the business. The 'return' is the amount earned after tax over the last twelve months. A higher profit will lead to a higher ROE. So, as a general rule, a high ROE is a good thing. That means it can be interesting to compare the ROE of different companies.

Does Kelso Technologies Have A Good ROE?

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, Kelso Technologies has a better ROE than the average (8.4%) in the Machinery industry.

That is a good sign. I usually take a closer look when a company has a better ROE than industry peers. For example you might check if insiders are buying shares.

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 issuing shares, retained earnings, 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 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.

Kelso Technologies's Debt And Its 24% ROE

One positive for shareholders is that Kelso Technologies does not have any net debt! Its high ROE indicates the business is high quality, but the fact that this was achieved without leverage is veritably impressive. 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.