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One of the best investments we can make is our own knowledge and skill sets. With that in mind, this article discusses how to use Return on Equity (ROE) to better understand your business. As a working example, use ROE to look at International Business Machines Corporation (NYSE:IBM).
ROE or Return on Equity is a useful tool for evaluating how effectively a company is able to generate returns on the investment it receives from its shareholders. In other words, it shows that we have succeeded in turning shareholder investment into profit.
Get the latest analysis on International Business Machines.
How to calculate return on equity
of Formula for Return on Equity teeth:
Return on Equity = Net Income (from Continuing Operations) ÷ Shareholders’ Equity
Therefore, based on the above formula, the ROE for International Business Machines is:
8.1% = US$1.8 billion ÷ US$22 billion (based on last 12 months to December 2022).
“Yield” is the annual profit. One way he conceptualizes this is that for every $1 of stockholders’ equity held, the company made $0.08 of his profit.
Is the ROE of international business machines high?
One easy way to determine if a company has a high return on equity is to compare it to the industry average. However, this method is only useful as a rough check, as companies within the same industry classification can vary considerably. As you can see from the image below, it has a lower ROE than the IT industry average (16%).
It’s certainly not ideal. However, low ROE is not necessarily bad. Even if your company has moderate to low debt levels, you may be able to use financial leverage to improve your bottom line. Companies with low ROE and high debt levels are too risky to be cautious. To see the five risks we’ve identified for International Business Machines, visit our risk dashboard for free.
How does debt affect ROE?
Virtually all businesses need capital to invest in their businesses and grow their profits. That cash can come from retained earnings, the issuance of new shares (shares), or debt. In the first and second cases ROE reflects the use of this cash to invest in the business. In the latter case, debt used for growth improves earnings but does not affect total capital. Thus, using debt boosts her ROE even though the core economics of the business remain the same.
Combining International Business Machines debt with an 8.1% return on equity
The heavy use of debt by International Business Machines is noteworthy, leading to a debt-to-equity ratio of 2.30. ROE is very low even with a large amount of debt. In our opinion it is not a good result. Credit markets change over time, so investors should carefully consider how a company might perform if it weren’t so easy to borrow.
summary
Return on equity is a useful measure of a company’s ability to generate profits and return them to shareholders. In our book, top quality companies have higher return on equity despite having less debt. All else being equal, the higher the ROE, the better.
However, when the quality of the business is high, the market will often bid up to a price that reflects this. Earnings growth relative to expectations reflected in the stock price is a particularly important consideration. Therefore, we encourage you to check out our free visualization of analyst forecasts for this company.
However, please note the following: International Business Machines may not be the best stock to buy. Now take a look at this free A list of interesting companies with high ROE and low debt.
Do you have feedback on this article? What interests you? contact directly with us. Or send an email to our editorial team (at) Simplywallst.com.
This article by Simply Wall St is general in nature. We provide comments based on historical data and analyst projections using only unbiased methodologies and our articles are not intended as financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. We aim to deliver long-term focused analysis based on fundamental data. Please note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Is not …
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