Metric analysis

Should Rocky Brands, Inc. (NASDAQ:RCKY) focus on improving this fundamental metric?

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. To keep the lesson grounded in practicality, we’ll use ROE to better understand Rocky Brands, Inc. (NASDAQ:RCKY).

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 short, ROE shows the profit that each dollar generates in relation to the investments of its shareholders.

How is ROE calculated?

The return on equity formula is:

Return on equity = Net income (from continuing operations) ÷ Equity

So, based on the above formula, the ROE for Rocky Brands is:

10.0% = $20 million ÷ $204 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 $0.10.

Does Rocky Brands have a good ROE?

Perhaps the easiest way to assess a company’s ROE is to compare it to the industry average. 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 chart below, Rocky Brands has a below average ROE (19%) in the Luxury industry classification.

NasdaqGS:RCKY Return on Equity September 13, 2022

Unfortunately, this is suboptimal. That being said, a low ROE is not always a bad thing, especially if the company has low leverage, as it still leaves room for improvement should the company take on more debt. 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 Rocky Brands by visiting our risk dashboard free on our platform here.

Why You Should Consider Debt When Looking at ROE

Virtually all businesses need money to invest in the business, 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.

Rocky Brands debt and its ROE of 10.0%

Rocky Brands uses a high amount of debt to increase returns. Its debt to equity ratio is 1.39. 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 way to compare the business quality of different companies. In our books, the highest quality companies have a high return on equity, despite low leverage. All things being equal, a higher ROE is better.

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. 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 Rocky Brands 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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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.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.