NYSE:AMRC).” data-reactid=”28″ type=”text”>While some investors are already well versed in financial metrics (hat tip), this article is for those who would like to learn about Return On Equity (ROE) and why it is important. To keep the lesson grounded in practicality, we’ll use ROE to better understand Ameresco, Inc. (NYSE:AMRC).
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How To Calculate Return On Equity?
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders’ Equity
So, based on the above formula, the ROE for Ameresco is:
9.3% = US$44m ÷ US$476m (Based on the trailing twelve months to June 2020).
The ‘return’ is the income the business earned over the last year. One way to conceptualize this is that for each $1 of shareholders’ capital it has, the company made $0.09 in profit.
Does Ameresco 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. 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 Ameresco has a similar ROE to the average in the Construction industry classification (10%).
on our platform here.” data-reactid=”55″ type=”text”>That isn’t amazing, but it is respectable. 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. You can see the 5 risks we have identified for Ameresco by visiting our risks dashboard for free on our platform here.
Why You Should Consider Debt When Looking At ROE
Companies usually need to invest money to grow their profits. That cash can come from issuing shares, retained earnings, or debt. In the case of the first and second options, the ROE will reflect this use of cash, for growth. In the latter case, the use of debt will improve the returns, but will not change the equity. Thus the use of debt can improve ROE, albeit along with extra risk in the case of stormy weather, metaphorically speaking.
Combining Ameresco’s Debt And Its 9.3% Return On Equity
Ameresco clearly uses a high amount of debt to boost returns, as it has a debt to equity ratio of 1.37. With a fairly low ROE, and significant use of debt, it’s hard to get excited about this business at the moment. Investors should think carefully about how a company might perform if it was unable to borrow so easily, because credit markets do change over time.
Return on equity is useful for comparing the quality of different businesses. In our books, the highest quality companies have high return on equity, despite low debt. 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.
visualization of analyst forecasts for the company.” data-reactid=”62″ type=”text”>But ROE is just one piece of a bigger puzzle, since high quality businesses often trade on high multiples of earnings. Profit growth rates, versus the expectations reflected in the price of the stock, are a particularly important to consider. So you might want to check this FREE visualization of analyst forecasts for the company.
free list of interesting companies, that have HIGH return on equity and low debt.” data-reactid=”67″ type=”text”>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.
This article by Simply Wall St is general in nature. 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.