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 American Tower Corporation (REIT) (NYSE:AMT).
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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
How To Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for American Tower Corporation (REIT) is:
42% = US$1.9b ÷ US$4.6b (Based on the trailing twelve months to March 2021).
The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.42 in profit.
Does American Tower Corporation (REIT) Have A Good ROE?
By comparing a company's ROE with its industry average, we can get a quick measure of how good it is. However, this method is only useful as a rough check, because companies do differ quite a bit within the same industry classification. As you can see in the graphic below, American Tower Corporation (REIT) has a higher ROE than the average (5.1%) in the REITs industry.NYSE:AMT Return on Equity June 13th 2021
That's what we like to see. Bear in mind, a high ROE doesn't always mean superior financial performance. Aside from changes in net income, a high ROE can also be the outcome of high debt relative to equity, which indicates risk. To know the 4 risks we have identified for American Tower Corporation (REIT) visit our risks dashboard for free.
The Importance Of Debt To Return On Equity
Companies usually need to invest money to grow their profits. That cash can come from retained earnings, issuing new shares (equity), 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. Thus the use of debt can improve ROE, albeit along with extra risk in the case of stormy weather, metaphorically speaking.
American Tower Corporation (REIT)'s Debt And Its 42% ROE
We think American Tower Corporation (REIT) uses a significant amount of debt to maximize its returns, as it has a significantly higher debt to equity ratio of 6.44. So although the company has an impressive ROE, the company might not have been able to achieve this without the significant use of debt.
Return on equity is useful for comparing the quality of different businesses. In our books, the highest quality companies have high return on equity, despite low debt. If two companies have around the same level of debt to equity, and one has a higher ROE, I'd generally prefer the one with higher ROE.
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 you might want to take a peek at this data-rich interactive graph of forecasts for the company.
Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of interesting companies.
This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
In This StoryAMT
- Despite Banning For-Profit Tutoring, China still Needs Companies like TAL Education Group (NYSE:TAL)
- With EPS Growth And More, Ally Financial (NYSE:ALLY) Is Interesting
- Did You Participate In Any Of United Parcel Service's (NYSE:UPS) Fantastic 126% Return ?
- Is There Now An Opportunity In Ford Motor Company (NYSE:F)?