Many investors are still educating themselves about the various metrics that can be useful when analyzing a stock. This article is for those who want to learn more about return on equity (ROE). As a learning-by-doing, we’ll take a look at the ROE to better understand GoHealth, Inc. (NASDAQ: GOCO).
ROE or return on equity is a useful tool to assess how effectively a company can generate the returns on investment it has received from its shareholders. In short, the ROE shows the profit that each dollar generates compared to the investments of its shareholders.
How is the ROE calculated?
the return on equity formula is:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the above formula, GoHealth’s ROE is:
2.4% = US $ 31 million ÷ US $ 1.3 billion (based on the last twelve months to September 2021).
“Return” refers to a company’s profits over the past year. This therefore means that for every $ 1 invested by its shareholder, the company generates a profit of $ 0.02.
Does GoHealth have a good ROE?
By comparing a company’s ROE with its industry average, we can get a quick measure of its quality. However, this method is only useful as a rough check, as companies differ a lot within a single industry classification. As shown in the image below, GoHealth has a lower ROE than the insurance industry average (11%).
NasdaqGS: GOCO Return on equity December 13, 2021
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 leverage levels are low. A business with high debt levels and low ROE is a combination we like to avoid given the risk involved. Our risk dashboard should have the 2 risks we identified for GoHealth.
The importance of debt to return on equity
Businesses generally need to invest money to increase their profits. The money for the investment can come from the profits of the previous year (retained earnings), from the issuance of new shares or from loans. In the first and second cases, the ROE will reflect this use of cash for investing in the business. In the latter case, the use of debt will improve returns, but will not affect equity. So, using debt can improve ROE, but with added risk in stormy weather, metaphorically speaking.
GoHealth’s debt and its ROE of 2.4%
Although GoHealth uses debt, its debt-to-equity ratio of 0.34 is still low. Its ROE is quite low and the company already has some debt, so shareholders are surely hoping for improvement. The prudent use of debt to increase returns is often very good for shareholders. However, this could reduce the company’s ability to take advantage of future opportunities.
Return on equity is useful for comparing the quality of different companies. In our books, the highest quality companies have a high return on equity, despite low leverage. All other things being equal, a higher ROE is preferable.
But when a company is of high quality, the market often offers it up to a price that reflects that. Especially important to consider are the growth rates of earnings, relative to expectations reflected in the stock price. So you might want to take a look at this data-rich interactive graph of business forecasts.
Sure, you might find a fantastic investment looking elsewhere. So take a look at this free list of interesting companies.
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