Metric analysis

Should Harsco Corporation (NYSE:HSC) focus on improving this fundamental metric?

While some investors are already familiar with financial metrics (hat trick), this article is for those who want to learn more about return on equity (ROE) and why it matters. We’ll use ROE to look at Harsco Corporation (NYSE:HSC), as a real-life example.

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 other words, it is a profitability ratio that measures the rate of return on capital contributed by the company’s shareholders.

Check out our latest analysis for Harsco

How is ROE calculated?

Return on equity can be calculated using the formula:

Return on equity = Net income (from continuing operations) ÷ Equity

So, based on the above formula, the ROE for Harsco is:

3.5% = $28 million ÷ $806 million (based on trailing 12 months to December 2021).

“Yield” refers to a company’s earnings over the past year. This means that for every dollar of shareholders’ equity, the company generated $0.03 in profit.

Does Harsco have a good ROE?

By comparing a company’s ROE with the average for its industry, we can get a quick measure of its quality. The limitation of this approach is that some companies are very different from others, even within the same industrial classification. As the image below clearly shows, Harsco has an ROE below the average (9.7%) for the business services industry.

NYSE: HSC Return on Equity April 8, 2022

It’s certainly not ideal. However, a low ROE is not always bad. If the company’s debt levels are moderate to low, there is always a chance that returns can be enhanced through the use of leverage. A company with high debt levels and low ROE is a combination we like to avoid given the risk involved. You can see the 2 risks we have identified for Harsco by visiting our risk dashboard for free on our platform here.

What is the impact of debt on return on equity?

Most businesses need money – from somewhere – to increase their profits. This money can come from issuing shares, retained earnings or debt. In the first two cases, the ROE will capture this use of capital to grow. In the latter case, debt used for growth will enhance returns, but will not affect total equity. So using debt can improve ROE, but with the added risk of stormy weather, metaphorically speaking.

Harsco’s debt and its ROE of 3.5%

Of note is Harsco’s heavy use of debt, leading to its debt-to-equity ratio of 1.69. Its ROE is quite low, even with the use of significant debt; this is not a good result, in our opinion. 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.

Conclusion

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 roughly the same level of debt and one has a higher ROE, I generally prefer the one with a higher ROE.

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. The rate at which earnings are likely to grow, relative to earnings growth expectations reflected in the current price, should also be considered. So I think it’s worth checking it out free analyst forecast report 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.

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.