Healthcare Realty Trust Incorporated (NYSE:HR) delivered a less impressive 6.45% ROE over the past year, compared to the 7.62% return generated by its industry. An investor may attribute an inferior ROE to a relatively inefficient performance, and whilst this can often be the case, knowing the nuts and bolts of the ROE calculation may change that perspective and give you a deeper insight into HR’s past performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of HR’s returns. Let me show you what I mean by this. See our latest analysis for HR
Breaking down Return on Equity
Return on Equity (ROE) weighs HR’s profit against the level of its shareholders’ equity. For example, if HR invests $1 in the form of equity, it will generate $0.06 in earnings from this. In most cases, a higher ROE is preferred; however, there are many other factors we must consider prior to making any investment decisions.
Return on Equity = Net Profit ÷ Shareholders Equity
Returns are usually compared to costs to measure the efficiency of capital. HR’s cost of equity is 8.49%. Given a discrepancy of -2.04% between return and cost, this indicated that HR may be paying more for its capital than what it’s generating in return. ROE can be broken down into three different ratios: net profit margin, asset turnover, and financial leverage. This is called the Dupont Formula:
ROE = profit margin × asset turnover × financial leverage
ROE = (annual net profit ÷ sales) × (sales ÷ assets) × (assets ÷ shareholders’ equity)
ROE = annual net profit ÷ shareholders’ equity
Essentially, profit margin shows how much money the company makes after paying for all its expenses. The other component, asset turnover, illustrates how much revenue HR can make from its asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable HR’s capital structure is. Since financial leverage can artificially inflate ROE, we need to look at how much debt HR currently has. The debt-to-equity ratio currently stands at a sensible 62.55%, meaning the ROE is a result of its capacity to produce profit growth without a huge debt burden.
What this means for you:
Are you a shareholder? HR’s below-industry ROE is disappointing, furthermore, its returns were not even high enough to cover its own cost of equity. However, investors shouldn’t despair since ROE is not inflated by excessive debt, which means HR still has room to improve shareholder returns by raising debt to fund new investments. If you’re looking for new ideas for high-returning stocks, you should take a look at our free platform to see the list of stocks with Return on Equity over 20%.
Are you a potential investor? If you are considering investing in HR, looking at ROE on its own is not enough to make a well-informed decision. I recommend you do additional fundamental analysis by looking through our most recent infographic report on Healthcare Realty Trust to help you make a more informed investment decision.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.