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. By way of learning-by-doing, we'll look at ROE to gain a better understanding of American Water Works Company, Inc. (NYSE:AWK).
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.
How Do You Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for American Water Works Company is:
9.6% = US$944m ÷ US$9.8b (Based on the trailing twelve months to December 2023).
The 'return' is the yearly profit. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.10 in profit.
Does American Water Works Company 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. If you look at the image below, you can see American Water Works Company has a similar ROE to the average in the Water Utilities industry classification (8.4%).
So while the ROE is not exceptional, at least its acceptable. While at least the ROE is not lower than the industry, its still worth checking what role the company's debt plays as high debt levels relative to equity may also make the ROE appear high. If so, this increases its exposure to financial risk. To know the 2 risks we have identified for American Water Works Company visit our risks dashboard for free.
How Does Debt Impact Return On Equity?
Virtually all companies need money to invest in the business, to grow profits. That cash can come from retained earnings, issuing new shares (equity), or debt. In the first two cases, the ROE will capture this use of capital to grow. 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 American Water Works Company's Debt And Its 9.6% Return On Equity
American Water Works Company clearly uses a high amount of debt to boost returns, as it has a debt to equity ratio of 1.26. With a fairly low ROE, and significant use of debt, it's hard to get excited about this business at the moment. Debt does bring extra risk, so it's only really worthwhile when a company generates some decent returns from it.
Conclusion
Return on equity is one way we can compare its 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 around the same level of debt to equity, and one has a higher ROE, I'd generally prefer the one with higher ROE.
But when a business is high quality, the market often bids it up to a price that reflects this. The rate at which profits are likely to grow, relative to the expectations of profit growth reflected in the current price, must be considered, too. So I think it may be worth checking this free report on analyst forecasts for the company.
Of course American Water Works Company 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.
Have feedback on this article? Concerned about the content?Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com. This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
最高の投資の一つは自分自身の知識とスキルセットに取り組むことです。その考えをもとに、この記事ではReturn On Equity(ROE)を使用してビジネスをより良く理解する方法について説明します。 実践学習を通じて、American Water Works Company、Inc.(NYSE:AWK)のROEを調べ、ビジネスをより深く理解します。
企業のROEを評価する最も簡単な方法は、同じ業種内の平均値と比較することです。このアプローチの制限は、同じ業種分類内でも、一部の企業は他の企業とはかなり異なる場合があるということです。下の画像を見ると、American Water Works Companyはウォーターユーティリティ業種分類(8.4%)の平均ROEに似た数字を示していることがわかります。
ROEが特別に素晴らしいわけではありませんが、少なくともそれは許容できる範囲内です。ROEが業界平均以下でなくても、企業の債務がROEを高く見せる役割を果たすかどうかを確認することは価値があります。この場合、金融リスクへの露出が増えるためです。American Water Works Companyに関連する2つのリスクを知るには、リスクダッシュボードを無料でご覧ください。
American Water Works Companyの債務と9.6%のROEを合わせると、同社はリターンを高めるためにほぼ全ての債務を利用していることが明らかです。申し訳ありませんが、ROEがかなり低いため、現時点ではこのビジネスに熱狂することが難しいです。債務は追加のリスクをもたらすので、企業がそれによってまともなリターンを生む場合にのみ本当に有益です。
オーストラリアでは、moomooの投資商品及びサービスはMoomoo Securities Australia Limitedによって提供され、オーストラリア証券投資委員会(ASIC)の管理を受けております(AFSL No. 224663)。「金融サービスガイド」、「利用規約」、「プライバシーポリシー」などの詳細は、Moomoo Securities Australia Limitedのウェブサイトhttps://www.moomoo.com/auでご確認いただけます。
オーストラリアでは、moomooの投資商品及びサービスはMoomoo Securities Australia Limitedによって提供され、オーストラリア証券投資委員会(ASIC)の管理を受けております(AFSL No. 224663)。「金融サービスガイド」、「利用規約」、「プライバシーポリシー」などの詳細は、Moomoo Securities Australia Limitedのウェブサイトhttps://www.moomoo.com/auでご確認いただけます。