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. By way of learning-by-doing, we'll look at ROE to gain a better understanding of Omnicom Group Inc. (NYSE:OMC).

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Omnicom Group

How To Calculate Return On Equity?

The formula for ROE is:

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

So, based on the above formula, the ROE for Omnicom Group is:

31% = US$1.6b ÷ US$5.0b (Based on the trailing twelve months to September 2024).

The 'return' refers to a company's earnings over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.31.

Does Omnicom Group Have A Good Return On Equity?

By comparing a company's ROE with its industry average, we can get a quick measure of how good it is. The limitation of this approach is that some companies are quite different from others, even within the same industry classification. Pleasingly, Omnicom Group has a superior ROE than the average (12%) in the Media industry.

That is a good sign. Bear in mind, a high ROE doesn't always mean superior financial performance. Especially when a firm uses high levels of debt to finance its debt which may boost its ROE but the high leverage puts the company at risk.

How Does Debt Impact ROE?

Companies usually need to invest money to grow their 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 used for growth will improve returns, but won't affect the total equity. In this manner the use of debt will boost ROE, even though the core economics of the business stay the same.

Combining Omnicom Group's Debt And Its 31% Return On Equity

It's worth noting the high use of debt by Omnicom Group, leading to its debt to equity ratio of 1.39. While no doubt that its ROE is impressive, we would have been even more impressed had the company achieved this with lower debt. 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.

Summary

Return on equity is useful for comparing the quality of different businesses. A company that can achieve a high return on equity without debt could be considered a high quality business. All else being equal, a higher ROE is better.

But when a business is high quality, the market often bids it up to a price that reflects this. It is important to consider other factors, such as future profit growth -- and how much investment is required going forward. So you might want to take a peek at this data-rich interactive graph of forecasts for the company.

Of course Omnicom Group may not be the best stock to buy. So you may wish to see this free collection of other companies that have high ROE and low debt.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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