Many investors are still learning the different metrics that can be useful when analyzing a stock. This article is for those who want to know more about return on equity (ROE). To keep the lesson grounded in practicality, we’ll use ROE to better understand Choice Properties Real Estate Investment Trust (IS:CHP.UN).
Return on Equity or ROE is a test of how effectively a company increases its value and manages investors’ money. In short, ROE shows the profit that each dollar generates in relation to the investments of its shareholders.
How to calculate return on equity?
The return on equity formula is:
Return on equity = Net income (from continuing operations) ÷ Equity
So, using the above formula, the ROE for Choice Properties Real Estate Investment Trust is:
13% = CAD 451 million ÷ CAD 3.5 billion (based on trailing 12 months to December 2020).
“Yield” is the income the business has earned over the past year. This means that for every Canadian dollar of equity, the company generated a profit of 0.13 Canadian dollars.
Does Choice Properties Real Estate Investment Trust have a good return on equity?
A simple way to determine if a company has a good return on equity is to compare it to the average for its industry. The limitation of this approach is that some companies are quite different from others, even within the same industrial classification. Fortunately, Choice Properties Real Estate Investment Trust has an above-average ROE (9.7%) for the REIT industry.
That’s what we like to see. However, keep in mind that a high ROE does not necessarily indicate efficient profit generation. A higher proportion of debt in a company’s capital structure can also result in a high ROE, where high debt levels could be a huge risk. Our risk dashboardshould involve the 4 risks we have identified for Choice Properties Real Estate Investment Trust.
Why You Should Consider Debt When Looking at ROE
Virtually all businesses need money to invest in the business, to increase their profits. The money for the investment can come from the previous year’s earnings (retained earnings), from issuing new shares or from borrowing. 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 boost returns, but will not impact equity. So using debt can improve ROE, but with the added risk of stormy weather, metaphorically speaking.
Combination of Choice Properties Real Estate Investment Trust’s debt and its return on equity of 13%
We believe Choice Properties Real Estate Investment Trust uses a significant amount of debt to maximize its returns, as it has a significantly higher debt-to-equity ratio of 3.30. Its ROE is respectable, but it’s not that impressive once you consider all of the debt.
Return on equity is a way to compare the business quality of different companies. A company that can earn a high return on equity without going into debt could be considered a high quality company. All things being equal, a higher ROE is better.
But ROE is only one piece of a larger puzzle, as high-quality companies often trade on high earnings multiples. Earnings growth rates, relative to expectations reflected in the share price, are particularly important to consider. So I think it’s worth checking it out free analyst forecast report for the company.
If you’d rather check out another company – one with potentially superior finances – then don’t miss this free list of attractive companies, which have a high return on equity and low debt.
This Simply Wall St article is general in nature. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.
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