With 99.2% ROE in the last year, Oceania Healthcare Limited (NZSE:OCA) appeared more efficient when we look at the industry average of 15.29% ROE. However, we must not ignore the role of leverage, which artificially inflates an ROE, making a poor performance look outstanding. See our latest analysis for OCA

ROE ratio basically calculates the net income as a percentage of total capital committed by shareholders, namely shareholders equity.Any ROE north of 20%, implying 20 cents return on every dollar invested, is favourable for any investor. But investors seek multiple assets to diversify risk and an industry-specific comparison makes more sense to achieve the goal of choosing the best among a given lot.

Return on Equity = Net Profit Shareholders Equity

For a company to create value for its shareholders, it must generate an ROE higher than the cost of equity. Unlike debt-holders, there is no predefined return for equity investors. However, an expected return to account for market risk can be arrived at using the Capital Asset Pricing Model. For OCA, it stands at 8.52% versus its ROE of 99.2%.

Oceania Healthcare (NZSE:OCA) Last Perf Jul 14th 17

When we break down ROE using a very popular method called Dupont Formula, it unfolds into three key ratios which are responsible for a companys profitability: net profit margin, asset turnover, and financial leverage. While higher margin and asset turnover indicate improved efficiency, investors should be cautious about the impact of increased leverage.

ROE = annual net profit shareholders equity

ROE = (annual net profit sales) (sales assets) (assets shareholders equity)

ROE = profit margin asset turnover financial leverage

Among the ratios affecting ROE, the profit margin is the most important as it highlights the operational efficiency of a company. To a potential investor, the ideal scenario would be profit increasing at a higher rate than the revenue.The asset turnover for a capital intensive industry such as bricks-and-mortar retail would be substantially lower than the e-commerce retail industry. A comparison with the industry can be drawn through ROA, which represents earnings as a percentage of assets. Oceania Healthcares ROA stood at 0.5% in the past year, compared to the industrys 6.25%.

Oceania Healthcare (NZSE:OCA) Historical Debt Jul 14th 17

The impact of leverage on ROE is reflected in a companys debt-equity profile. Rapidly rising debt compared to equity, while profit margin and asset turnover underperform, raises a red flag on the ROE. Its important as a company can inflate its ROE by consistently increasing debt despite weak operating performance. OCAs debt to equity ratio currently stands at 3.45. Investors should be cautious about any sharp change in this ratio, more so if its due to increasing debt.

While ROE can be calculated through a very simple calculation, investors should look at various ratios by breaking it down and how each of them affects the return to understand the strengths and weakness of a company. Its one of the few ratios which stitches together performance metrics from the income statement and the balance sheet. What are the analysts projection of Oceania Healthcares ROE in three years? I recommend you see our latest FREE analysis report to find out!

If you are not interested in OCA anymore, you can use our free platform to see my list of stocks with Return on Equity over 20%.

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Oceania Healthcare Limited (NZSE:OCA) Delivered A Better ROE Than The Industry, Here's Why - Simply Wall St