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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. To keep the lesson grounded in practicality, we'll use ROE to better understand JELD-WEN Holding, Inc. (NYSE:JELD).
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
See our latest analysis for JELD-WEN Holding
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for JELD-WEN Holding is:
18% = US$143m ÷ US$812m (Based on the trailing twelve months to March 2022).
The 'return' is the income the business earned over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.18.
Does JELD-WEN Holding 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. The limitation of this approach is that some companies are quite different from others, even within the same industry classification. The image below shows that JELD-WEN Holding has an ROE that is roughly in line with the Building industry average (19%).
So while the ROE is not exceptional, at least its acceptable. Although the ROE is similar to the industry, we should still perform further checks to see if the company's ROE is being boosted by high debt levels. If a company takes on too much debt, it is at higher risk of defaulting on interest payments. Our risks dashboardshould have the 2 risks we have identified for JELD-WEN Holding.
The Importance Of Debt To Return On Equity
Most companies need money -- from somewhere -- 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 debt required for growth will boost returns, but will not impact the shareholders' equity. That will make the ROE look better than if no debt was used.
JELD-WEN Holding's Debt And Its 18% ROE
It's worth noting the high use of debt by JELD-WEN Holding, leading to its debt to equity ratio of 2.13. There's no doubt its ROE is decent, but the very high debt the company carries is not too exciting to see. Debt does bring extra risk, so it's only really worthwhile when a company generates some decent returns from it.