Metric analysis

Should HireRight Holdings Corporation (NYSE:HRT) 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. Learning by doing, we will look at ROE to better understand HireRight Holdings Corporation (NYSE: HRT).

Return on equity or ROE is a key metric used to gauge how effectively a company’s management is using the company’s capital. In simpler terms, it measures a company’s profitability relative to equity.

Check out our latest analysis for HireRight Holdings

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 above formula, the ROE for HireRight Holdings is:

6.3% = $30 million ÷ $478 million (based on trailing 12 months to June 2022).

“Yield” refers to a company’s earnings over the past year. One way to conceptualize this is that for every $1 of share capital it has, the firm has made a profit of $0.06.

Does HireRight Holdings have a good ROE?

Perhaps the easiest way to assess a company’s ROE is to compare it to the industry average. 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, HireRight Holdings has a below average ROE (16%) in the Professional services sector.

deer

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.

The Importance of Debt to Return on Equity

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, the use of debt will improve returns, but will not change equity. This will make the ROE better than if no debt was used.

The debt of HireRight Holdings and its ROE of 6.3%

HireRight Holdings is clearly using a high amount of debt to boost returns, as it has a leverage ratio of 1.45. 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. In our books, the highest quality companies have a high return on equity, despite low leverage. If two companies have the same ROE, I would generally prefer the one with less debt.

But ROE is only one piece of a larger puzzle, as high-quality companies often trade on high earnings multiples. It is important to consider other factors, such as future earnings growth and the amount of investment needed in the future. So I think it’s worth checking it out free analyst forecast report for the company.

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

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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.

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