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While some investors are already well-versed in monetary metrics (full stop), this article is for those who need to be more informed about return to equity (ROE) and why it matters. We’ll use ROE to take a look at Ford Motor Company (NYSE: F), as a real-world example.
Return on equity or ROE is a key metric used to evaluate how successfully a company’s control uses the company’s equity. In other words, it is a profitability index that measures the rate of return on the capital contributed through the company’s shareholders.
Check out our latest research for Ford Motor
The return-to-equity formula is as follows:
Return on Equity = Net Income (from Continuing Operations) ÷ Stockholders’ Equity
So, based on the formula above, Ford Motor’s ROE is:
14% = $6. 1 billion ÷ $44 billion (based on the last twelve months through September 2023).
“Performance” refers to a company’s profits over the following year. Another way to look at it is that for every dollar of capital, the company can make a profit of $0. 14.
Arguably, the simplest way to assess a company’s ROE is to compare it to the industry average. It is vital to note that this measure is far from perfect, as corporations differ particularly within the same industry classification. The symbol below shows that Ford Motor has an ROE roughly in line with the automotive industry average (14%).
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. You can see the 3 risks we have identified for Ford Motor by visiting our risks dashboard for free on our platform here.
Companies regularly have to invest coins to increase their profits. These currencies can come from retained earnings, the issuance of new stocks, or debt. In the first two cases, the NSO will capture this use of capital for growth. In the latter case, the use of debt will return, but it will not replace equity. Therefore, the use of debt can be ROE, while at the same time being accompanied, metaphorically speaking, by an additional threat in the event of a storm.
We think Ford Motor uses a significant amount of debt to maximize its returns, as it has a significantly higher debt to equity ratio of 3.22. Its ROE is respectable, but it’s not so impressive once you consider all of the debt.
Return on equity is a useful indicator of a company’s ability to generate profits and return them to shareholders. In our view, higher-quality corporations have a high return on equity, despite their low debt. All things being equal, a higher ROE is preferable.
Having said that, while ROE is a useful indicator of business quality, you’ll have to look at a whole range of factors to determine the right price to buy a stock. It is important to consider other factors, such as future profit growth — and how much investment is required going forward. So I think it may be worth checking this free report on analyst forecasts for the company.
If you want to see any other company, one with potentially impressive monetary effects, don’t miss this extensive list of attractive companies, which have a HIGH return on equity and low debt.
Any comments on this article? Worried about content? Contact us directly. You can also email the editorial team (at) Simplywallst. com. This Simply Wall St article is general in nature. We provide observations based on old knowledge and forecasts from analysts who only use unbiased methods and our articles are not intended to constitute monetary advice. It is not advice for buying or selling shares and does not take into account your purposes or monetary situation. Our purpose is to provide you with long-term targeted research based on basic knowledge. Please note that our research may not take into account the latest announcements from price-sensitive companies or qualitative factors. Wall St simply has no position in any of the stocks mentioned.