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 Pinnacle West Capital Corporation (NYSE:PNW), by way of a worked example.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How To Calculate Return On Equity?
Return on equity can be calculated by using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Pinnacle West Capital is:
8.5% = US$539m ÷ US$6.3b (Based on the trailing twelve months to March 2024).
The 'return' is the yearly profit. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.09 in profit.
Does Pinnacle West Capital Have A Good ROE?
By comparing a company's ROE with its industry average, we can get a quick measure of how good it is. Importantly, this is far from a perfect measure, because companies differ significantly within the same industry classification. The image below shows that Pinnacle West Capital has an ROE that is roughly in line with the Electric Utilities industry average (8.9%).
NYSE:PNW Return on Equity June 27th 2024
That isn't amazing, but it is respectable. Although the ROE is similar to the industry, we should still perform further checks to see if the company's ROE is being boosted by high debt levels. If a company takes on too much debt, it is at higher risk of defaulting on interest payments. To know the 2 risks we have identified for Pinnacle West Capital visit our risks dashboard for free.
How Does Debt Impact Return On Equity?
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 two cases, the ROE will capture this use of capital to grow. In the latter case, the debt required for growth will boost returns, but will not impact the shareholders' equity. In this manner the use of debt will boost ROE, even though the core economics of the business stay the same.
Pinnacle West Capital's Debt And Its 8.5% ROE
It's worth noting the high use of debt by Pinnacle West Capital, leading to its debt to equity ratio of 1.46. With a fairly low ROE, and significant use of debt, it's hard to get excited about this business at the moment. Debt increases risk and reduces options for the company in the future, so you generally want to see some good returns from using it.
Summary
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. 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 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.
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com
私たちができる最高の投資の1つは、自己の知識とスキルセットに投資することです。その考えに基づいて、この記事では、Return On Equity(ROE)を使用してビジネスをよりよく理解する方法を説明します。 この説明に沿って、Pinnacle West Capital Corporation(NYSE:PNW)を調べて、ROEを用いた実例を示します。
企業のROEを業種平均と比較することにより、その良さを簡単に判断することができます。ただし、企業は同じ業種分類内でも大きく異なるため、これは決して完璧な指標ではありません。 次の図は、Pinnacle West CapitalのROEが、公益事業業界平均(8.9%)とほぼ同じであることを示しています。
NYSE: PNW Return on Equity June 27th 2024
それは素晴らしいものではありませんが、それは尊敬されるものです。ROEが業界平均に似ていても、企業のROEが高い負債レベルに支えられているかどうかを確認するために、さらにチェックを行う必要があります。企業があまりにも多くの債務を負うと、利息支払いのデフォルトリスクが高くなります。Pinnacle West Capitalの特定の2つのリスクについては、リスクダッシュボードで無料で確認できます。
Pinnacle West Capitalは負債を多く抱えており、その負債/自己資本比率は1.46です。比較的低いROEと負債の使用の高さにより、現時点ではこのビジネスに興奮するのは難しいと言えます。負債はリスクを増やし、将来の企業の選択肢を減らすため、通常はその使用に対して良いリターンが見込めることが必要です。
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。