While some investors are already well versed in financial metrics (hat tip), this article is for those who would like to learn about Return On Equity (ROE) and why it is important. By way of learning-by-doing, we'll look at ROE to gain a better understanding of Accel Entertainment, Inc. (NYSE:ACEL).
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Put another way, it reveals the company's success at turning shareholder investments into profits.
View our latest analysis for Accel Entertainment
How To Calculate Return On Equity?
ROE can be calculated by using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Accel Entertainment is:
37% = US$68m ÷ US$181m (Based on the trailing twelve months to September 2022).
The 'return' is the yearly profit. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.37.
Does Accel Entertainment Have A Good ROE?
By comparing a company's ROE with its industry average, we can get a quick measure of how good it is. Importantly, this is far from a perfect measure, because companies differ significantly within the same industry classification. Pleasingly, Accel Entertainment has a superior ROE than the average (23%) in the Hospitality industry.
NYSE:ACEL Return on Equity January 5th 2023
That is a good sign. However, bear in mind that a high ROE doesn't necessarily indicate efficient profit generation. Aside from changes in net income, a high ROE can also be the outcome of high debt relative to equity, which indicates risk. Our risks dashboardshould have the 2 risks we have identified for Accel Entertainment.
How Does Debt Impact Return On Equity?
Virtually all companies need money to invest in the business, to grow profits. That cash can come from issuing shares, retained earnings, or debt. In the first two cases, the ROE will capture this use of capital to grow. In the latter case, the use of debt will improve the returns, but will not change the equity. Thus the use of debt can improve ROE, albeit along with extra risk in the case of stormy weather, metaphorically speaking.
Combining Accel Entertainment's Debt And Its 37% Return On Equity
It's worth noting the high use of debt by Accel Entertainment, leading to its debt to equity ratio of 2.88. There's no doubt the ROE is impressive, but it's worth keeping in mind that the metric could have been lower if the company were to reduce its 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.
Conclusion
Return on equity is useful for comparing the quality of different businesses. Companies that can achieve high returns on equity without too much debt are generally of good quality. 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 I think it may be worth checking this free report on analyst forecasts for the company.
Of course Accel Entertainment 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.
