Metric loss

Should Safehold Inc. (NYSE:SAFE) 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 Safehold Inc. (NYSE: SAFE).

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

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 Safehold is:

4.0% = $81 million ÷ $2.0 billion (based on trailing 12 months to March 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 $0.04.

Does Safehold have a good return on equity?

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 shown in the chart below, Safehold has a below average ROE (6.5%) in the REIT industry classification.

NYSE: Safe Return on Equity July 29, 2022

That’s not what we like to see. 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. A company with high debt levels and low ROE is a combination we like to avoid given the risk involved. To know the 3 risks that we have identified for Safehold visit our risk dashboard for free.

What is the impact of debt on ROE?

Virtually all businesses need money to invest in the business, to increase their profits. This money can come from issuing shares, retained earnings 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, the debt necessary for growth will boost returns, but will not impact equity. In this way, the use of debt will increase ROE, even though the core economics of the business remains the same.

Safehold’s debt and its ROE of 4.0%

Safehold clearly uses a high amount of debt to increase returns, as its debt-to-equity ratio is 1.45. The combination of a rather low ROE and heavy reliance on debt is not particularly attractive. Debt increases risk and reduces options for the business in the future, so you generally want to see good returns using it.

Summary

Return on equity is a way to compare the business quality of different companies. 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. Earnings growth rates, relative to expectations reflected in the share price, are particularly important to consider. So you might want to check this out for FREE visualization of analyst forecasts for the business.

Sure Safehold 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.