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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 Portland General Electric Company (NYSE:POR), by way of a worked example.
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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.
See our latest analysis for Portland General Electric
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 Portland General Electric is:
9.4% = US$343m ÷ US$3.6b (Based on the trailing twelve months to September 2024).
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 Portland General Electric Have A Good Return On Equity?
One simple way to determine if a company has a good return on equity is to compare it to the average for its industry. Importantly, this is far from a perfect measure, because companies differ significantly within the same industry classification. The image below shows that Portland General Electric has an ROE that is roughly in line with the Electric Utilities industry average (9.3%).
So while the ROE is not exceptional, at least its acceptable. Even if the ROE is respectable when compared to the industry, its worth checking if the firm's ROE is being aided by high debt levels. If a company takes on too much debt, it is at higher risk of defaulting on interest payments. You can see the 3 risks we have identified for Portland General Electric by visiting our risks dashboard for free on our platform here.
The Importance Of Debt To Return On Equity
Virtually all companies need money to invest in the business, to grow 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 used for growth will improve returns, but won't affect the total equity. Thus the use of debt can improve ROE, albeit along with extra risk in the case of stormy weather, metaphorically speaking.
Combining Portland General Electric's Debt And Its 9.4% Return On Equity
It's worth noting the high use of debt by Portland General Electric, leading to its debt to equity ratio of 1.22. Its ROE is quite low, even with the use of significant debt; that's not a good result, in our opinion. Debt does bring extra risk, so it's only really worthwhile when a company generates some decent returns from it.