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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. We'll use ROE to examine Sienna Senior Living Inc. (TSE:SIA), by way of a worked example.
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 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 Sienna Senior Living is:
8.0% = CA$38m ÷ CA$481m (Based on the trailing twelve months to December 2024).
The 'return' is the yearly profit. One way to conceptualize this is that for each CA$1 of shareholders' capital it has, the company made CA$0.08 in profit.
View our latest analysis for Sienna Senior Living
Does Sienna Senior Living 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. However, this method is only useful as a rough check, because companies do differ quite a bit within the same industry classification. As is clear from the image below, Sienna Senior Living has a lower ROE than the average (10%) in the Healthcare industry.
That's not what we like to see. 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 Sienna Senior Living.
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 issuing shares, retained earnings, 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.
Sienna Senior Living's Debt And Its 8.0% ROE
Sienna Senior Living does use a high amount of debt to increase returns. It has a debt to equity ratio of 2.11. The combination of a rather low ROE and significant use of debt is not particularly appealing. Debt increases risk and reduces options for the company in the future, so you generally want to see some good returns from using it.