Many investors are still learning the different metrics that can be useful when analyzing a stock. This article is for those who want to know more about return on equity (ROE). We’ll use ROE to look at Bruker Corporation (NASDAQ:BRKR), as a real-world example.
ROE or return on equity is a useful tool for evaluating how effectively a company can generate returns on the investment it has received from its shareholders. In other words, it is a profitability ratio that measures the rate of return on capital contributed by the company’s shareholders.
See our latest analysis for Bruker
How is ROE calculated?
The return on equity formula is:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the formula above, the ROE for Bruker is:
27% = $285 million ÷ $1.0 billion (based on trailing 12 months to March 2022).
“Yield” is the income the business has earned over the past year. Another way to think about this is that for every dollar of equity, the company was able to make a profit of $0.27.
Does Bruker 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. However, this method is only useful as a rough check, as companies differ quite a bit within the same industry classification. As the image below clearly shows, Bruker has a better than average ROE (17%) in the life science industry.
This is clearly a positive point. Keep in mind that a high ROE does not always mean superior financial performance. A higher proportion of debt in a company’s capital structure can also result in a high ROE, where high debt levels could be a huge risk.
The Importance of Debt to Return on Equity
Virtually all businesses need money to invest in the business, to increase their profits. The money for the investment can come from the previous year’s earnings (retained earnings), from issuing new shares or from borrowing. In the first and second case, the ROE will reflect this use of cash for investment in the business. In the latter case, the use of debt will improve returns, but will not change equity. In this way, the use of debt will increase ROE, even though the core economics of the business remains the same.
Bruker’s debt and its ROE of 27%
Bruker is clearly using a high amount of debt to boost returns, as its debt-to-equity ratio is 1.18. Its ROE is quite impressive, but it probably would have been lower without the use of debt. Debt increases risk and reduces options for the business in the future, so you generally want to see good returns using it.
Return on equity is useful for comparing the quality of different companies. Companies that can earn high returns on equity without too much debt are generally of good quality. If two companies have the same ROE, I would generally prefer the one with less debt.
That said, while ROE is a useful indicator of a company’s quality, you’ll need to consider a whole host of factors to determine the right price to buy a stock. It is important to consider other factors, such as future earnings growth and the amount of investment needed in the future. You might want to check out this FREE analyst forecast visualization for the company.
If you’d rather check out another company – one with potentially superior finances – then don’t miss this free list of attractive companies, which have a high return on equity and low debt.
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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.