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. Learning by doing, we’ll look at ROE to better understand Hyatt Hotels Corporation (NYSE:H).
ROE or return on equity is a useful tool for evaluating how effectively a company can generate returns on the investment it has received from its shareholders. In simple terms, it is used to assess the profitability of a company in relation to its equity.
How do you calculate return on equity?
The return on equity formula is:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the above formula, the ROE for Hyatt Hotels is:
6.4% = $224 million ÷ $3.5 billion (based on trailing 12 months to June 2022).
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 $0.06 in profit.
Do Hyatt hotels have a good ROE?
A simple way to determine if a company has a good return on equity is to compare it to the average for its industry. The limitation of this approach is that some companies are quite different from others, even within the same industrial classification. As the image below clearly shows, Hyatt Hotels has a below average ROE (23%) in the Hospitality industry.
Unfortunately, this is suboptimal. However, a low ROE is not always bad. If the company’s debt levels are moderate to low, there is always the possibility that returns could be enhanced through the use of leverage. When a company has a low ROE but a high level of debt, we would be cautious because the risk involved is too high. You can see the 4 risks we have identified for Hyatt hotels by visiting our risk dashboard free on our platform here.
Why You Should Consider Debt When Looking at ROE
Companies generally need to invest money to increase their profits. This money can come from retained earnings, issuing new stock (shares), or debt. In the first and second case, the ROE will reflect this use of cash for investment in the business. In the latter case, debt used for growth will enhance returns, but will not affect total equity. In this way, the use of debt will increase ROE, even though the core economics of the business remains the same.
Combine Hyatt hotels debt and its 6.4% return on equity
Hyatt Hotels uses a high amount of debt to increase returns. Its debt to equity ratio is 1.08. Its ROE is quite low, even with the use of significant debt; this is not a good result, in our view. 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 roughly the same level of debt and one has a higher ROE, I generally prefer the one with a higher ROE.
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. So you might want to take a look at this data-rich interactive chart of business forecasts.
Sure Hyatt Hotels may not be the best stock to buy. So you might want to see this free collection of other companies that have high ROE and low debt.
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