What Do These Ratios Tell Us About Unilever?

LONDON -- Before I decide whether to buy a company's shares, I always like to look at two core financial ratios -- return on equity and net gearing.

These two ratios provide an indication of how successful a company is at generating profits using shareholders' funds and debt, and they have a strong influence on dividend payments and share price growth.

Today, I'm going to take a look at consumer goods giant and Fool favorite Unilever (LSE: ULVR  ) (NYSE: UL  )  to see how attractive it looks on these two measures.

Return on equity
The return a company generates on its shareholders' funds is known as return on equity, or ROE. ROE can be calculated by dividing a company's annual earnings by its equity (i.e., the difference between its total assets and its total liabilities) and is expressed as a percentage.

Let's start with a look at Unilever's ROE over the last five years:

Unilever 2008 2009 2010 2011 2012 Average
ROE 45% 30.6% 32% 29.6% 30.4% 33.5%

Unilever's five-year average ROE of 33.5% is impressive, but to see how competitive it really is, we need to compare it to some of its peers, which I'll do in a moment.

What about debt?
One weakness of ROE is that it doesn't show how much debt a company is using to boost its returns. A good way of assessing a company's debt levels is by looking at its net gearing -- the ratio of net debt to equity.

In the table below, I've listed Unilever's net gearing and ROE alongside those of its main U.K. rival, Reckitt Benckiser:

Company Net Gearing 5-Year
Average ROE
Unilever 48.5% 33.5%
Reckitt Benckiser 40.2% 35.3%

Unilever's products are mostly staple goods that we will always buy, regardless of economic conditions. This provides Unilever with pricing power, which is also helped by customers' loyalty to the firm's brands.

I think that Reckitt's growth may be harder to sustain, as it is dependent on high margins and a move into health care, which could expose it to tough new competition.

Unilever's focus on food and personal hygiene products, and its strong emerging market growth, look much more attractive to me.

Is Unilever a buy?
Trading on a P/E of 20, Unilever's shares are not cheap at the moment, but they do provide access to a high-quality income stream.

This year's rising market has pushed Unilever's dividend yield down to the FTSE 100 average, and at the firm's current share price, I'd hold. However, if the market's recent losses continue, and Unilever's shares drop below 2,500 pence, I'd rate them a buy.

Finding market-beating returns
Unilever is one of five shares that the Fool's expert team of analysts have selected for their latest special report, "5 Shares to Retire On."

The other four shares are equally impressive, and I'd strongly recommend you take a look. I own three of the shares featured in this free report, and I don't mind admitting they are among the most successful investments I've ever made.

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