Many investors are still learning the different metrics that can be useful when analyzing a stock. This article is for those who want to know more about return on equity (ROE). Learning by doing, we will look at ROE to better understand Fraport AG (ETR:FRA).
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 simpler terms, it measures a company’s profitability relative to equity.
See our latest analysis for Fraport
How do you calculate return on equity?
Return on equity can be calculated using the formula:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the formula above, the ROE for Fraport is:
1.3% = €51M ÷ €3.8B (based on trailing 12 months to March 2022).
The “return” is the annual profit. Another way to think about this is that for every €1 of equity, the company was able to make €0.01 of profit.
Does Fraport 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. It is important to note that this measure is far from perfect, as companies differ significantly within the same industry classification. As shown in the graph below, Fraport has a below average ROE (11%) in the infrastructure industry classification.
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. When a company has a low ROE but a high level of debt, we would be cautious because the risk involved is too high. Our risk dashboard should have the 2 risks we identified for Fraport.
Why You Should Consider Debt When Looking at ROE
Companies generally need to invest money 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. This will make the ROE better than if no debt was used.
Fraport’s debt and its ROE of 1.3%
Fraport is clearly using a high amount of debt to boost its returns, as its debt-to-equity ratio is 2.69. The combination of a rather low ROE and heavy reliance on debt is not particularly attractive. 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.
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. If two companies have the same ROE, I would generally prefer the one with less debt.
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.
But note: Fraport may not be the best stock to buy. So take a look at this free list of interesting companies with high ROE and low debt.
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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.