Is New China Life Insurance Company Ltd.’s (SHSE:601336) 8.3% ROE Strong Compared To Its Industry?

Many investors are still learning about the different metrics that can be useful when analyzing a stock. This article is for those who want to know about Return on Equity (ROE). We'll use ROE to examine New China Life Insurance Co., Ltd. (SHSE:601336) through an example.

Return on equity or ROE is an important measure used to assess how efficiently a company's management is using the company's capital. In simple terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for New China Life Insurance

How is ROE calculated?

Return on equity can be calculated using the formula:

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

So, based on the above formula, the ROE for New China Life Insurance is:

8.3% = CN¥8.7b ÷ CN¥105b (based on trailing twelve months to December 2023).

'Return' is the annual profit. One way to conceptualize this is that for every CN¥1 of shareholders' capital, the company earned CN¥0.08 in profit.

Does New China Life Insurance have a good return on equity?

Probably the easiest way to assess a company's ROE is to compare it to the average for its industry. The limitation of this approach is that some companies are quite different from others, even within the same industry classification. The image below shows that New China Life Insurance's ROE is roughly in line with the insurance industry average (9.2%).

So while the ROE isn't exceptional, it's at least acceptable. Even though the ROE is respectable compared to the industry, it is still worth checking if the firm's ROE is being aided by high debt levels. If a company borrows too much, it has a higher risk of defaulting on interest payments.

Why You Should Consider Debt When Looking at ROE

Most companies need money – from somewhere – to increase their profits. That cash could come from issuing shares, retained earnings or debt. In the first and second cases, ROE will reflect this use of cash for investment in the business. In the latter case, the debt required for growth will boost returns, but will not impact shareholders' equity. In this way the use of debt will boost ROE even though the core economics of the business will remain the same.

New China Life Insurance's debt and its 8.3% ROE

It is worth noting New China Life Insurance's high use of debt, leading to its debt-to-equity ratio of 1.21. Its ROE is quite low even after using significant debt; In our opinion, this is not a good result. Investors should think carefully about how a company would perform if it was unable to borrow so easily, as credit markets change over time.

Summary

Return on equity is a useful indicator of a business's ability to generate profits and return them to shareholders. Companies that can achieve high returns on equity without having a lot of debt are generally of good quality. If two companies have the same ROE, I would generally prefer the company with less debt.

Having said that, while ROE is a useful indicator of the quality of a business, you need to look at a whole range of factors to determine the right price to buy a stock. It is especially important to consider the profit growth rate, versus expectations reflected in the stock price. So you might want to check out this free visualization of analyst forecasts for the company.

Absolutely, You may find a great investment by looking elsewhere. So take a look at this Free List of interesting companies.

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This article from Simply Wall St is of a general nature. We only provide commentary based on historical data and analyst forecasts using unbiased methodology and our articles are not intended to provide financial advice. It does not recommend buying or selling any stock, and does not take into account your objectives, or your financial situation. Our goal is to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any of the stocks mentioned.