Many investors are still educating themselves about the various metrics that can be useful when analyzing a stock. This article is for those who want to learn more about return on equity (ROE). To keep the lesson practical, we’ll use ROE to better understand Macy’s, Inc. (NYSE: M).
Return on equity or ROE is a test of how effectively a company increases its value and manages investor money. In short, the ROE shows the profit that each dollar generates compared to the investments of its shareholders.
See our latest review for Macy’s
How to calculate return on equity?
ROE can be calculated using the formula:
Return on equity = Net income (from continuing operations) Ã· Equity
So, based on the above formula, Macy’s ROE is:
16% = US $ 516 million Ã· US $ 3.1 billion (based on the last twelve months to July 2021).
The “return” is the annual profit. Another way to look at this is that for every dollar of equity, the company was able to make $ 0.16 in profit.
Does Macy’s have a good ROE?
By comparing a company’s ROE with its industry average, we can get a quick measure of its quality. However, this method is only useful as a rough check, as companies differ a lot within a single industry classification. You can see from the graph below that Macy’s has an ROE quite close to the Multiline Retail industry average (19%).
It is neither particularly good nor bad. Although the ROE is similar to that of the industry, we still need to perform additional checks to see if the company’s ROE is being boosted by high levels of debt. If so, it increases their exposure to financial risk. Our risk dashboard should contain the 5 risks we have identified for Macy’s.
What is the impact of debt on return on equity?
Most businesses need money – from somewhere – to increase their profits. The money for the investment can come from the profits of the previous year (retained earnings), from the issuance of new shares or from loans. 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 necessary for growth will increase returns, but will have no impact on equity. In this way, the use of debt will increase the ROE, even if the basic economy of the business remains the same.
Combine Macy’s Debt and its 16% Return on Equity
Noteworthy is Macy’s high reliance on debt, which earned it a debt-to-equity ratio of 1.54. There is no doubt that his ROE is decent, but the company’s very high debt is not too exciting to see. Leverage increases risk and reduces options for the business in the future, so you usually want to get good returns using it.
Return on equity is a useful indicator of a company’s ability to generate profits and return them to shareholders. In our books, the highest quality companies have a high return on equity, despite low leverage. If two companies have roughly the same level of debt to equity and one has a higher ROE, I would generally prefer the one with a higher ROE.
But when a company is of high quality, the market often offers it up to a price that reflects that. Especially important to consider are the growth rates of earnings, relative to expectations reflected in the stock price. So I think it’s worth checking this out free analyst forecast report for the company.
Sure, you might find a fantastic investment looking elsewhere. So take a look at this free list of interesting companies.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in the mentioned stocks.
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