While some investors are already familiar with financial metrics (hat tip), this article is for those who want to learn about return on equity (ROE) and its importance. Investigating Equifax Inc. using ROE (New York Stock Exchange:EFX), as a working example.
ROE or return on equity is a useful tool for evaluating how effectively a company can generate returns on the investment it receives from its shareholders. In other words, it is a profitability ratio that measures the rate of return on the capital provided by a company’s shareholders.
See our latest analysis for Equifax.
How is ROE calculated?
of ROE calculation formula teeth:
Return on equity = Net income (from continuing operations) ÷ Shareholders’ equity
So, based on the above formula, Equifax’s ROE is:
13% = USD 529 million ÷ USD 4.2 billion (based on trailing twelve months to June 2023).
“Return” is the profit over the past 12 months. Another way to think of it is that for every $1 worth of stock, the company was able to earn him $0.13 in profit.
Does Equifax have a good ROE?
By comparing a company’s ROE with the industry average, you can easily measure how well a company performs. However, this method is only useful as a cursory check, as there is considerable variation between companies within the same industry classification. If you look at the chart below, you can see that his ROE for Equifax is quite close to the company average. professional services industry (15%).
That’s not surprising, but it’s admirable. ROE is similar to the industry, but we need to further check whether a company’s ROE is being boosted by high debt levels. When a company takes on a large amount of debt, there is a high risk that interest payments will be delayed.
What impact does debt have on ROE?
Most companies need money from somewhere to grow their profits. That cash can come from retained earnings, issuing new shares (equity), or debt. In the first and his second cases, ROE reflects the use of cash for investment in the business. In the latter case, using debt increases returns but does not change equity. Thus, the use of debt increases his ROE even if the core economics of the business remain unchanged.
Combine Equifax’s debt with a 13% return on equity.
Equifax clearly uses a large amount of debt to generate profits, as it has a debt-to-equity ratio of 1.35. Although the company’s ROE is quite good, the amount of debt the company currently has is not ideal. Debt brings extra risk, so debt is only really worth it if a company generates some profit from it.
summary
Return on equity is a useful indicator of a company’s ability to generate profits and return them to shareholders. According to our book, the highest quality companies have a higher return on equity despite having less debt. If two companies have approximately the same level of debt-to-equity, but one company has a higher ROE, I usually prefer the company with the higher ROE.
That said, while ROE is a useful indicator of the quality of a business, you need to consider a variety of factors to determine the right price to buy a stock. It is important to consider other factors such as future profit growth and how much investment is required in the future.So you might want to take a look at this Data-rich interactive graph showing company forecasts.
of course Equifax may not be the best stock to buy.So you might want to see this free A collection of other companies with high ROE and low debt.
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This article by Simply Wall St is general in nature. We provide commentary using only unbiased methodologies, based on historical data and analyst forecasts, and articles are not intended to be financial advice. This is not a recommendation to buy or sell any stock, and does not take into account your objectives or financial situation. We aim to provide long-term, focused analysis based on fundamental data. Note that our analysis may not factor in the latest announcements or qualitative material from price-sensitive companies. Simply Wall St has no position in any stocks mentioned.