In This Article:
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. By way of learning-by-doing, we'll look at ROE to gain a better understanding of Phibro Animal Health Corporation (NASDAQ:PAHC).
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How Do You 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 Phibro Animal Health is:
7.8% = US$19m ÷ US$247m (Based on the trailing twelve months to December 2024).
The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.08 in profit.
Check out our latest analysis for Phibro Animal Health
Does Phibro Animal Health Have A Good ROE?
One 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 industry classification. As shown in the graphic below, Phibro Animal Health has a lower ROE than the average (21%) in the Pharmaceuticals industry classification.
That certainly isn't ideal. However, a low ROE is not always bad. If the company's debt levels are moderate to low, then there's still a chance that returns can be improved via the use of financial leverage. A high debt company having a low ROE is a different story altogether and a risky investment in our books. Our risks dashboard should have the 3 risks we have identified for Phibro Animal Health.
The Importance Of Debt To Return On Equity
Virtually all companies need money to invest in the business, to grow profits. That cash can come from issuing shares, retained earnings, or debt. In the first and second cases, the ROE will reflect this use of cash for investment in the business. In the latter case, the use of debt will improve the returns, but will not change the equity. In this manner the use of debt will boost ROE, even though the core economics of the business stay the same.
Phibro Animal Health's Debt And Its 7.8% ROE
It seems that Phibro Animal Health uses a huge volume of debt to fund the business, since it has an extremely high debt to equity ratio of 3.06. The combination of a rather low ROE and high debt to equity is a negative, in our book.