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 Vail Resorts, Inc. (NYSE: MTN).
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 simple terms, it is used to assess the profitability of a company in relation to its equity.
Check out our latest analysis for Vail Resorts
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 Vail Resorts is:
16% = $333 million ÷ $2.1 billion (based on trailing 12 months to April 2022).
“Yield” is the income the business has earned over the past year. Another way to think about this is that for every dollar of equity, the company was able to make a profit of $0.16.
Does Vail Resorts have a good return on equity?
By comparing a company’s ROE with the average for its industry, we can get a quick measure of its quality. 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, Vail Resorts has a below average ROE (23%) in the hospitality industry.
Unfortunately, this is suboptimal. However, we believe that a lower ROE could still mean that a company has the opportunity to improve its returns through the use of leverage, provided its existing debt levels are low. A company with high debt levels and low ROE is a combination we like to avoid given the risk involved. To learn about the 2 risks we have identified for Vail Resorts, visit our Risk Dashboard for free.
The Importance of Debt to Return on Equity
Companies generally need to invest money to increase their profits. This money can come from issuing shares, retained earnings or debt. In the case of the first and second options, the ROE will reflect this use of cash, for growth. In the latter case, the debt necessary for growth will boost returns, but will not impact shareholders’ equity. In this way, the use of debt will increase ROE, even though the core economics of the business remains the same.
Combining Vail Resorts debt and its 16% return on equity
Vail Resorts uses a high amount of debt to increase returns. Its debt to equity ratio is 1.16. Although its ROE is quite respectable, the amount of debt the company is currently carrying is not ideal. Debt brings additional risk, so it’s only really worth it when a business is generating decent returns.
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.
But when a company is of high quality, the market often gives it a price that reflects that. The rate at which earnings are likely to grow, relative to earnings growth expectations reflected in the current price, should also be considered. You might want to check out this FREE analyst forecast visualization for the company.
But note: Vail Resorts 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.