One of the best investments we can make is in our own knowledge and skills. With that in mind, this article will explain how we can use return on equity (ROE) to better understand a business. To keep the lesson grounded in practicality, we’ll use ROE to better understand LTC Properties, Inc. (NYSE: LTC).
Return on equity or ROE is an important factor for a shareholder to consider as it tells them how much of their capital is being reinvested. In simpler terms, it measures a company’s profitability relative to equity.
Check out our latest analysis for LTC properties
How to calculate return on equity?
ROE can be calculated using the formula:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the formula above, the ROE for SLD properties is:
7.7% = $57 million ÷ $743 million (based on trailing 12 months to March 2022).
The “yield” is the profit of the last twelve months. This means that for every dollar of shareholders’ equity, the company generated $0.08 in profit.
Does LTC Properties have a good ROE?
A simple way to determine if a company has a good return on equity is to compare it to the average for its industry. It is important to note that this measure is far from perfect, as companies differ significantly within the same industry classification. You can see in the chart below that LTC Properties has an ROE quite close to the REIT industry average (6.5%).
So, although the ROE is not exceptional, it is at least acceptable. Although at least the ROE is not lower than the industry, it is always worth checking the role that the company’s debt plays, since high levels of debt relative to equity can also give the impression that the ROE is high. If a company takes on too much debt, it runs a higher risk of defaulting on interest payments. To learn about the 2 risks we have identified for LTC Properties, visit our Risk Dashboard for free.
What is the impact of debt on ROE?
Companies generally need to invest money to increase their profits. This money can come from retained earnings, issuing new stock (shares), or debt. In the first two cases, the ROE will capture this use of capital to grow. In the latter case, the debt necessary for growth will boost returns, but will not impact equity. In this way, the use of debt will increase ROE, even though the core economics of the business remains the same.
LTC Properties’ debt and its ROE of 7.7%
Of note is the heavy use of debt by LTC Properties, leading to its debt-to-equity ratio of 1.03. With a fairly low ROE and a significant reliance on debt, it is difficult to get enthusiastic about this activity at the moment. Investors need to think carefully about how a company would perform if it weren’t able to borrow so easily, as credit markets change over time.
Return on equity is a useful indicator of a company’s ability to generate profits and return them to shareholders. A company that can earn a high return on equity without going into debt could be considered a high quality company. If two companies have the same ROE, I would generally prefer the one with less debt.
But when a company is of high quality, the market often gives it a price that reflects that. It is important to consider other factors, such as future earnings growth and the amount of investment needed in the future. So I think it’s worth checking it out free analyst forecast report for the company.
Sure, you might find a fantastic investment by looking elsewhere. So take a look at this free list of interesting companies.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.