Metric analysis

Should SunCoke Energy, Inc. (NYSE:SXC) 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. To keep the lesson grounded in practicality, we’ll use ROE to better understand SunCoke Energy, Inc. (NYSE: SXC).

Return on Equity or ROE is a test of how effectively a company increases its value and manages investors’ money. In other words, it is a profitability ratio that measures the rate of return on capital contributed by the company’s shareholders.

See our latest analysis for SunCoke Energy

How is ROE calculated?

ROE can be calculated using the formula:

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

So, based on the above formula, the ROE for SunCoke Energy is:

15% = $88 million ÷ $574 million (based on trailing 12 months to June 2022).

The “yield” is the profit of the last twelve months. Another way to think about this is that for every dollar of equity, the company was able to make a profit of $0.15.

Does SunCoke Energy 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 very different from others, even within the same industrial classification. As the image below clearly shows, SunCoke Energy has an ROE below the average (21%) for the metals and mining industry.

NYSE: SXC Return on Equity September 2, 2022

It’s certainly not ideal. However, a low ROE is not always bad. If the company’s debt levels are moderate to low, there is always a chance that returns can 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. To learn about the 3 risks we have identified for SunCoke Energy, visit our risk dashboard for free.

What is the impact of debt on ROE?

Companies generally need to invest money 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 two cases, the ROE will capture this use of capital to grow. In the latter case, debt used for growth will enhance returns, but will not affect total equity. This will make the ROE better than if no debt was used.

Combine SunCoke Energy’s debt and 15% return on equity

SunCoke Energy is clearly using a high amount of debt to boost its returns, as its debt-to-equity ratio is 1.02. While its ROE is respectable, it’s worth bearing in mind that there’s usually a limit to the amount of debt a company can use. 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.

Summary

Return on equity is useful for comparing the 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.

But ROE is only one piece of a larger puzzle, as high-quality companies often trade on high earnings multiples. Earnings growth rates, relative to expectations reflected in the share price, are particularly important to consider. You might want to check out this FREE analyst forecast visualization for the company.

But note: SunCoke Energy 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.

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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