U.S. markets open in 9 hours 29 minutes
  • S&P Futures

    3,439.25
    +16.50 (+0.48%)
     
  • Dow Futures

    28,216.00
    +116.00 (+0.41%)
     
  • Nasdaq Futures

    11,723.75
    +73.50 (+0.63%)
     
  • Russell 2000 Futures

    1,619.90
    +8.60 (+0.53%)
     
  • Crude Oil

    40.61
    -0.22 (-0.54%)
     
  • Gold

    1,903.70
    -8.00 (-0.42%)
     
  • Silver

    24.58
    -0.12 (-0.48%)
     
  • EUR/USD

    1.1777
    +0.0004 (+0.04%)
     
  • 10-Yr Bond

    0.7610
    +0.0170 (+2.28%)
     
  • Vix

    29.18
    +1.77 (+6.46%)
     
  • GBP/USD

    1.2951
    +0.0010 (+0.08%)
     
  • USD/JPY

    105.5300
    +0.1000 (+0.09%)
     
  • BTC-USD

    11,742.38
    +685.37 (+6.20%)
     
  • CMC Crypto 200

    239.16
    +5.49 (+2.35%)
     
  • FTSE 100

    5,884.65
    -34.93 (-0.59%)
     
  • Nikkei 225

    23,579.57
    -91.56 (-0.39%)
     

Should We Be Delighted With Domino's Pizza Enterprises Limited's (ASX:DMP) ROE Of 36%?

Simply Wall St
·4 mins read

Many investors are still learning about the various metrics that can be useful when analysing a stock. This article is for those who would like to learn about Return On Equity (ROE). To keep the lesson grounded in practicality, we'll use ROE to better understand Domino's Pizza Enterprises Limited (ASX:DMP).

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.

Check out our latest analysis for Domino's Pizza Enterprises

How To 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 Domino's Pizza Enterprises is:

36% = AU$143m ÷ AU$393m (Based on the trailing twelve months to June 2020).

The 'return' is the yearly profit. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.36 in profit.

Does Domino's Pizza Enterprises Have A Good Return On Equity?

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, Domino's Pizza Enterprises has a superior ROE than the average (8.7%) in the Hospitality industry.

roe
roe

That's what we like to see. Bear in mind, a high ROE doesn't always mean superior financial performance. 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.

How Does Debt Impact ROE?

Virtually all companies need money to invest in the business, to grow profits. That cash can come from retained earnings, issuing new shares (equity), or debt. In the first and second cases, the ROE will reflect this use of cash for investment in the business. In the latter case, the use of debt will improve the returns, but will not change the equity. In this manner the use of debt will boost ROE, even though the core economics of the business stay the same.

Combining Domino's Pizza Enterprises' Debt And Its 36% Return On Equity

Domino's Pizza Enterprises clearly uses a high amount of debt to boost returns, as it has a debt to equity ratio of 1.80. 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. Debt does bring extra risk, so it's only really worthwhile when a company generates some decent returns from it.

Summary

Return on equity is one way we can compare its business quality of different companies. In our books, the highest quality companies have high return on equity, despite low debt. If two companies have the same ROE, then I would generally prefer the one with less debt.

Having said that, while ROE is a useful indicator of business quality, you'll have to look at a whole range 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 going forward. So I think it may be worth checking this free report on analyst forecasts for the company.

If you would prefer check out another company -- one with potentially superior financials -- then do not miss this free list of interesting companies, that have HIGH return on equity and low debt.

This article by Simply Wall St is general in nature. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.