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 EastGroup Properties Inc (NYSE:EGP).
EastGroup Properties has a ROE of 9.6%, based on the last twelve months. Another way to think of that is that for every $1 worth of equity in the company, it was able to earn $0.096.
How Do You Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit ÷ Shareholders’ Equity
Or for EastGroup Properties:
9.6% = US$80m ÷ US$841m (Based on the trailing twelve months to June 2018.)
Most know that net profit is the total earnings after all expenses, but the concept of shareholders’ equity is a little more complicated. It is the capital paid in by shareholders, plus any retained earnings. You can calculate shareholders’ equity by subtracting the company’s total liabilities from its total assets.
What Does Return On Equity Signify?
Return on Equity measures a company’s profitability against the profit it has kept for the business (plus any capital injections). The ‘return’ is the yearly profit. That means that the higher the ROE, the more profitable the company is. So, all else being equal, a high ROE is better than a low one. Clearly, then, one can use ROE to compare different companies.
Does EastGroup Properties 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. However, this method is only useful as a rough check, because companies do differ quite a bit within the same industry classification. As is clear from the image below, EastGroup Properties has a better ROE than the average (6.4%) in the reits industry.
That is a good sign. In my book, a high ROE almost always warrants a closer look. For example you might check if insiders are buying shares.
Why You Should Consider Debt When Looking At ROE
Most companies need money — from somewhere — to grow their profits. That cash can come from issuing shares, retained earnings, 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 debt used for growth will improve returns, but won’t affect the total equity. In this manner the use of debt will boost ROE, even though the core economics of the business stay the same.
Combining EastGroup Properties’s Debt And Its 9.6% Return On Equity
It’s worth noting the significant use of debt by EastGroup Properties, leading to its debt to equity ratio of 1.30. The company doesn’t have a bad ROE, but it is less than ideal tht it has had to use debt to achieve its returns. Debt does bring some extra risk, so it’s only really worthwhile when a company generates some decent returns from it.
The Key Takeaway
Return on equity is one way we can compare the business quality of different companies. Companies that can achieve high returns on equity without too much debt are generally of good quality. If two companies have the same ROE, then I would generally prefer the one with less debt.
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 I think it may be worth checking this free report on analyst forecasts for the company.
Of course EastGroup Properties 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.
To help readers see past 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. For errors that warrant correction please contact the editor at firstname.lastname@example.org.