U.S. markets closed
  • S&P Futures

    3,365.50
    -17.50 (-0.52%)
     
  • Dow Futures

    27,224.00
    -141.00 (-0.52%)
     
  • Nasdaq Futures

    11,539.25
    -48.75 (-0.42%)
     
  • Russell 2000 Futures

    1,574.70
    -14.30 (-0.90%)
     
  • Crude Oil

    38.65
    -0.92 (-2.32%)
     
  • Gold

    1,907.70
    -4.20 (-0.22%)
     
  • Silver

    24.43
    -0.14 (-0.57%)
     
  • EUR/USD

    1.1781
    -0.0008 (-0.07%)
     
  • 10-Yr Bond

    0.7780
    -0.0230 (-2.87%)
     
  • Vix

    33.35
    +0.89 (+2.74%)
     
  • GBP/USD

    1.3035
    -0.0006 (-0.04%)
     
  • USD/JPY

    104.3100
    -0.1840 (-0.18%)
     
  • BTC-USD

    13,732.72
    -22.04 (-0.16%)
     
  • CMC Crypto 200

    272.17
    +10.88 (+4.17%)
     
  • FTSE 100

    5,728.99
    -63.02 (-1.09%)
     
  • Nikkei 225

    23,410.76
    -75.04 (-0.32%)
     

Is Standard Motor Products, Inc.'s (NYSE:SMP) ROE Of 13% Impressive?

Simply Wall St

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. We'll use ROE to examine Standard Motor Products, Inc. (NYSE:SMP), by way of a worked example.

Over the last twelve months Standard Motor Products has recorded a ROE of 13%. Another way to think of that is that for every $1 worth of equity in the company, it was able to earn $0.13.

See our latest analysis for Standard Motor Products

How Do You Calculate ROE?

The formula for return on equity is:

Return on Equity = Net Profit ÷ Shareholders' Equity

Or for Standard Motor Products:

13% = US$65m ÷ US$485m (Based on the trailing twelve months to June 2019.)

It's easy to understand the 'net profit' part of that equation, but 'shareholders' equity' requires further explanation. It is all the money paid into the company from shareholders, plus any earnings retained. The easiest way to calculate shareholders' equity is to subtract the company's total liabilities from the total assets.

What Does ROE Signify?

ROE looks at the amount a company earns relative to the money it has kept within the business. The 'return' is the profit over the last twelve months. That means that the higher the ROE, the more profitable the company is. So, as a general rule, a high ROE is a good thing. Clearly, then, one can use ROE to compare different companies.

Does Standard Motor Products Have A Good Return On Equity?

Arguably the easiest way to assess company's ROE is to compare it with the average in its industry. The limitation of this approach is that some companies are quite different from others, even within the same industry classification. You can see in the graphic below that Standard Motor Products has an ROE that is fairly close to the average for the Auto Components industry (15%).

NYSE:SMP Past Revenue and Net Income, August 26th 2019
NYSE:SMP Past Revenue and Net Income, August 26th 2019

That isn't amazing, but it is respectable. ROE doesn't tell us if the share price is low, but it can inform us to the nature of the business. For those looking for a bargain, other factors may be more important. If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

How Does Debt Impact ROE?

Most companies need money -- from somewhere -- to grow their profits. The cash for investment can come from prior year profits (retained earnings), issuing new shares, or borrowing. In the first and second cases, the ROE will reflect this use of cash for investment in the business. In the latter case, the debt used for growth will improve returns, but won't affect the total equity. That will make the ROE look better than if no debt was used.

Standard Motor Products's Debt And Its 13% ROE

Standard Motor Products has a debt to equity ratio of 0.28, which is far from excessive. Its very respectable ROE, combined with only modest debt, suggests the business is in good shape. Careful use of debt to boost returns is often very good for shareholders. However, it could reduce the company's ability to take advantage of future opportunities.

The Bottom Line On ROE

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 ROE is just one piece of a bigger puzzle, since high quality businesses often trade on high multiples of earnings. It is important to consider other factors, such as future profit growth -- and how much investment is required going forward. So you might want to check this FREE visualization of 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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.