Metric analysis

Keyera Corp. (TSE:KEY) focus on improving this fundamental metric?

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. We will use ROE to review Keyera Corp. (TSE:KEY), as a concrete 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 simpler terms, it measures a company’s profitability relative to equity.

Discover our latest analysis for Keyera

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 Keyera is:

12% = CAD$324 million ÷ CAD$2.7 billion (based on trailing 12 months to December 2021).

The “return” is the annual profit. Another way to think about this is that for every CA$1 of equity, the company was able to make a profit of CA$0.12.

Does Keyera 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, Keyera has an ROE below the average (17%) for the oil and gas industry.

TSX: KEY Return on Equity March 2, 2022

Unfortunately, this is suboptimal. However, we believe that a lower ROE could still mean that a company has the opportunity to improve its returns through the use of leverage, provided its existing debt levels are low. A highly leveraged company with a low ROE is a whole other story and a risky investment on our books. To learn about the 2 risks we have identified for Keyera, visit our risk dashboard for free.

What is the impact of debt on ROE?

Most businesses need money – from somewhere – to increase their profits. This money can come from issuing stocks, retained earnings or debt. 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. This will make the ROE better than if no debt was used.

Keyera’s debt and its ROE of 12%

Keyera is clearly using a high amount of debt to boost returns, as it has a leverage ratio of 1.32. There’s no doubt that its ROE is decent, but the company’s sky-high debt isn’t too exciting to see. Debt brings additional risk, so it’s only really worth it when a business is generating decent returns.

Summary

Return on equity is a way to compare the business quality of different companies. 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. You might want to take a look at this data-rich interactive chart of the company’s forecast.

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.

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.