One of the best investments we can make is in our own knowledge and skills. With that in mind, this article will discuss how we can use Return on Equity (ROE) to better understand a business. As a learning-by-doing, we’ll take a look at the ROE to better understand the Industrial Logistics Properties Trust (NASDAQ: ILPT).
Return on equity or ROE is a key metric used to assess the efficiency with which the management of a business is using business capital. In simpler terms, it measures a company’s profitability relative to equity.
See our latest review for Industrial Logistics Properties Trust
How to calculate return on equity?
The return on equity formula is:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the above formula, the ROE for Industrial Logistics Properties Trust is:
9.7% = US $ 97 million ÷ US $ 996 million (based on the last twelve months to September 2021).
The “return” is the annual profit. This means that for every dollar in shareholders’ equity, the company generated $ 0.10 in profit.
Does Industrial Logistics Properties Trust have a good ROE?
Perhaps the easiest way to assess a company’s ROE is to compare it to the industry average. The limitation of this approach is that some companies are very different from others, even within the same industry classification. As you can see in the graph below, Industrial Logistics Properties Trust has an above-average ROE (6.0%) for the REIT industry.
This is what we love to see. Keep in mind that a high ROE doesn’t always mean superior financial performance. Especially when a business uses high levels of leverage to finance its debt, which can increase its ROE, but high leverage puts the business at risk. Our risk dashboard should include the 3 risks that we have identified for Industrial Logistics Properties Trust.
The importance of debt to return on equity
Most businesses need money – from somewhere – to increase their profits. This liquidity can come from the issuance of 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 necessary for growth will increase returns, but will have no impact on equity. This will make the ROE better than if no debt was used.
Industrial Logistics Properties Trust’s debt and its ROE of 9.7%
Industrial Logistics Properties Trust uses a large amount of debt to increase returns. He has a debt ratio of 1.00. With a fairly low ROE and heavy use of debt, it’s hard to get excited about this business right now. Leverage increases risk and reduces options for the business in the future, so you usually want to get good returns using it.
Return on equity is one way to compare the business quality of different companies. A business that can earn a high return on equity without going into debt could be considered a high quality business. If two companies have roughly the same level of debt to equity and one has a higher ROE, I would generally prefer the one with a higher ROE.
But when a company is of high quality, the market often offers it up to a price that reflects that. Especially important to consider are the growth rates of earnings, relative to expectations reflected in the share price. You might want to take a look at this data-rich interactive chart of the forecast for the business.
If you would rather consult with another company – one with potentially superior finances – then don’t miss this free list of interesting companies, which have a HIGH return on equity and low leverage.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in any of the stocks mentioned.
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