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’ll look at ROE to better understand Reservoir Media, Inc. (NASDAQ: RSVR).
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 Reservoir Media
How do you calculate return on equity?
the ROE formula is:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the above formula, the ROE for Reservoir Media is:
3.4% = $12 million ÷ $343 million (based on trailing 12 months to December 2021).
The “yield” is the profit of the last twelve months. This therefore means that for every $1 of investment by its shareholder, the company generates a profit of $0.03.
Does Reservoir Media have a good return on equity?
A simple way to determine if a company has a good return on equity is to compare it to the average for its industry. It is important to note that this measure is far from perfect, as companies differ significantly within the same industry classification. As the image below clearly shows, Reservoir Media has a lower ROE than the entertainment industry average (9.8%).
Unfortunately, this is suboptimal. That being said, a low ROE is not always a bad thing, especially if the company has low debt, as it still leaves room for improvement if the company were to take on more debt. A highly leveraged company with a low ROE is a whole other story and a risky investment on our books. Our risk dashboard should have the 3 risks we identified for Reservoir Media.
What is the impact of debt on ROE?
Virtually all businesses need money to invest in the business, to increase their profits. The money for the investment can come from the previous year’s earnings (retained earnings), from issuing new shares or from borrowing. In the first and second case, the ROE will reflect this use of cash for investment in the business. In the latter case, the debt necessary for growth will boost returns, but will not impact equity. This will make the ROE better than if no debt was used.
Combine Reservoir Media’s debt and its return on equity of 3.4%
Although Reservoir Media has some debt, with a debt-to-equity ratio of just 0.66, we wouldn’t say the debt is excessive. Its ROE is quite low and the company already has debt, so shareholders are surely hoping for an improvement. 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 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.
But when a company is of high quality, the market often gives it a price that reflects that. 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.
But note: Reservoir Media 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.