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 Installed Building Products, Inc. (NYSE:IBP).
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How Do You Calculate Return On Equity?
Return on equity 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 Installed Building Products is:
36% = US$244m ÷ US$670m (Based on the trailing twelve months to December 2023).
The 'return' is the yearly profit. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.36.
Does Installed Building Products Have A Good ROE?
One simple way to determine if a company has a good return on equity is to compare it to the average for its industry. Importantly, this is far from a perfect measure, because companies differ significantly within the same industry classification. As you can see in the graphic below, Installed Building Products has a higher ROE than the average (15%) in the Consumer Durables industry.
That's what we like to see. With that said, a high ROE doesn't always indicate high profitability. 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. Our risks dashboardshould have the 2 risks we have identified for Installed Building Products.
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 case of the first and second options, the ROE will reflect this use of cash, for growth. In the latter case, the debt required for growth will boost returns, but will not impact the shareholders' equity. That will make the ROE look better than if no debt was used.
Combining Installed Building Products' Debt And Its 36% Return On Equity
It's worth noting the high use of debt by Installed Building Products, leading to its debt to equity ratio of 1.29. While no doubt that its ROE is impressive, we would have been even more impressed had the company achieved this with lower debt. Debt increases risk and reduces options for the company in the future, so you generally want to see some good returns from using it.
Conclusion
Return on equity is a useful indicator of the ability of a business to generate profits and return them to shareholders. 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 ROE is just one piece of a bigger puzzle, since high quality businesses often trade on high multiples of earnings. Profit growth rates, versus the expectations reflected in the price of the stock, are a particularly important to consider. So I think it may be worth checking this free report on analyst forecasts for the company.
Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of interesting companies.
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.
自分自身の知識とスキルを向上させるための、最も良い投資の一つは自己投資である。その観点から、本記事ではReturn On Equity (ROE)を使ってビジネスを理解する方法について、解説する。 言葉ではなく実践を通じて学んでいく形で、Installed Building Products, Inc.(NYSE:IBP)を例に、ROEを見ていくことでビジネスをより深く理解していく。
企業のROEが良いかどうかを判断する簡単な方法の一つは、業種の平均と比較することです。しかし、同じ業種であっても、企業によっては大きく異なるため、完全な指標とは言えません。以下のグラフを見ると、消費関連業種の平均(15%)よりもInstalled Building ProductsのROEが高いことがわかります。
良い結果です。ただし、高いROEが常に高い利益を示すわけではありません。特に、企業が財務を高いレベルで負債で資金調達する場合、ROEは高くなる可能性がありますが、高いレバレッジは会社を危険に晒す場合があります。 Installed Building Productsの2つのリスクを示すリスクダッシュボードがあります。
Installed Building Productsの債務を含めたROEの高さに注目する価値があります。債務/資本比率が1.29と高いため、ROEが印象的であることには間違いありませんが、同社がより低い債務を抱えた場合は、より印象的な結果であったでしょう。負債はリスクを増大させ、今後の発展のオプションを減少させるため、利回りが高くてもよい結果ではありません。