Metric analysis

Should the Vornado Realty Trust (NYSE:VNO) 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’ll use ROE to look at Vornado Realty Trust (NYSE:VNO), as a real-life example.

Return on Equity or ROE is a test of how effectively a company increases its value and manages investors’ money. In short, ROE shows the profit that each dollar generates in relation to the investments of its shareholders.

Check out our latest analysis for Vornado Realty Trust

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, Vornado Realty Trust’s ROE is:

2.9% = $208 million ÷ $7.2 billion (based on trailing 12 months to December 2021).

The “yield” is the amount earned after tax over the last twelve months. This means that for every dollar of shareholders’ equity, the company generated $0.03 in profit.

Does Vornado Realty Trust 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. However, this method is only useful as a rough check, as companies differ quite a bit within the same industry classification. If you look at the image below, you can see that Vornado Realty Trust has a below average ROE (6.8%) in the REIT industry classification.

NYSE:VNO Return on Equity February 17, 2022

That’s not what we like to see. 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 company with high debt levels and low ROE is a combination we like to avoid given the risk involved. Our risk dashboard should have the 3 risks we identified for Vornado Realty Trust.

Why You Should Consider Debt When Looking at ROE

Virtually all businesses need money to invest in the business, to increase their profits. This money can come from retained earnings, issuing new stock (shares), or debt. In the first two cases, the ROE will capture this use of capital to grow. In the latter case, the use of debt will improve returns, but will not change equity. So using debt can improve ROE, but with the added risk of stormy weather, metaphorically speaking.

Vornado Realty Trust’s debt and its ROE of 2.9%

Vornado Realty Trust uses a high amount of debt to increase returns. Its debt to equity ratio is 1.21. The combination of a rather low ROE and heavy reliance on debt is not particularly attractive. Debt brings additional risk, so it’s only really worth it when a business is generating decent returns.

Summary

Return on equity is a useful indicator of a company’s ability to generate profits and return them to shareholders. Companies that can earn high returns on equity without too much debt are generally of good quality. All things being equal, a higher ROE is better.

But when a company is of high quality, the market often gives it a price that reflects that. Earnings growth rates, relative to expectations reflected in the share price, are particularly important to consider. You might want to take a look at this data-rich interactive chart of the company’s forecast.

Sure, you might find a fantastic investment by looking elsewhere. So take a look at this free list of interesting companies.

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.