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Many investors are still learning about the various metrics that can be useful when analyzing a stock. This article is intended for those who want to learn more about return on equity (ROE). To keep the lesson hands-on, we’ll use ROE to better understand BT Group plc (LON:BT.A).
ROE, or return on equity, is a useful tool for assessing how effectively a company is generating returns on the investment received from its shareholders. In other words, it shows the company’s success in turning shareholders’ investments into profits.
Check out our latest analysis for BT Group
How do you calculate return on equity?
That Formula for return on equity is:
Return on Equity = Net Income (from continuing operations) ÷ Equity
So, based on the formula above, the ROE for BT Group is:
9.0% = UK£1.1b ÷ UK£12b (Based on trailing 12 months to March 2022).
“Return” is the amount earned over the past 12 months after tax. This means that for every £1 worth of equity, the company makes £0.09 profit.
Does BT Group have a good ROE?
Arguably the easiest way to evaluate a company’s ROE is to compare it to its industry average. The limitation of this approach is that some companies differ greatly from others, even within the same industry classification. If you look at the image below, you can see that BT Group has a lower than average (15%) ROE in the telecom industry classification.
That’s definitely not ideal. However, we believe that a lower ROE could still mean that a company has an opportunity to improve its returns through the use of leverage, provided its existing debt is low. A highly leveraged company with a low ROE is a whole different story and a risky investment on our books. You can see the 3 risks we have identified for BT Group by visiting our Risk Dashboard for free on our platform here.
How does debt affect ROE?
Almost all companies need money to invest in the business and make a profit. This money can come from retained earnings, the issuance of new shares (equity), or debt. In the first and second cases, the ROE will reflect this use of cash to invest in the company. In the latter case, the debt used for growth improves returns but does not affect overall capital. This makes the ROE look better than if no debt were used.
Combines BT Group’s debt and its 9.0% return on equity
BT Group uses a large amount of debt to boost returns. The gearing ratio is 1.89. With a fairly low ROE and a significant debt footprint, it’s hard to get excited about this business right now. Debt comes with an additional risk, so it’s only worth it if a company can get a decent return on it.
summary
Return on equity is useful for comparing the quality of different companies. A company that can generate a high return on equity with no debt could be considered a high quality company. Generally, if two companies have the same ROE, I’d prefer the one with less debt.
But when a company is of high quality, the market often offers it at a price that reflects that. It is important to consider other factors such as B. future earnings growth – and how much investment is required in the future. So you might want to check out this FREE visualization of analyst forecasts for the company.
Naturally BT Group might not be the best stock to buy. You might want to see this free Collection of other companies with high ROE and low debt.
Do you have any feedback about this article? Concerned about the content? Get in touch directly with us. Alternatively, send an email to the editorial team (at) simplywallst.com.
This Simply Wall St article is of a general nature. We provide comments based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended as financial advice. It is not a recommendation to buy or sell any stock and does not take into account your goals or financial situation. Our goal is to offer you long-term focused analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any of the stocks mentioned.
