One of the best investments we can make is in our own knowledge and skills. With that in mind, this article will discuss how we can use Return on Equity (ROE) to better understand a business. We’ll use the ROE to take a look at Global Ship Lease, Inc. (NYSE: GSL), using a real-world example.
Return on equity or ROE is an important factor for a shareholder to consider because it tells them how efficiently their capital is being reinvested. In other words, it reveals the company’s success in turning shareholders’ investments into profits.
Check out our latest review for Global Ship Lease
How is the ROE calculated?
Return on equity can be calculated using the formula:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the above formula, the ROE for Global Ship Lease is:
11% = US $ 64 million ÷ US $ 593 million (based on the last twelve months to June 2021).
The “return” is the profit of the last twelve months. This means that for every dollar in shareholders’ equity, the company generated $ 0.11 in profit.
Does Global Ship Lease have a good return on equity?
By comparing a company’s ROE with its industry average, we can get a quick measure of its quality. However, this method is only useful as a rough check, as companies differ a lot within a single industry classification. You can see in the graph below that Global Ship Lease has a ROE quite close to the shipping industry average (11%).
So even if the ROE is not exceptional, it is at least acceptable. While at least the ROE is not lower than that of the industry, it is still worth checking out the role that corporate debt plays, as high levels of debt relative to equity can also make the ROE appear high. If so, it increases their exposure to financial risk. You can see the 3 risks we have identified for Global Ship Lease by visiting our risk dashboard for free on our platform here.
Why You Should Consider Debt When Looking At ROE
Almost all businesses need money to invest in the business, to increase their profits. This liquidity can come from retained earnings, the issuance of new shares (shares) or debt. In the first and second cases, the ROE will reflect this use of cash for investing in the business. In the latter case, the debt necessary for growth will increase returns, but will have no impact on equity. In this way, the use of debt will increase the ROE, even if the basic economy of the business remains the same.
Global Ship Lease’s debt and its 11% ROE
Global Ship Lease clearly uses a high amount of debt to boost returns, as it has a debt-to-equity ratio of 1.38. Its ROE is quite low, even with significant recourse to debt; this is not a good result, in our opinion. Debt comes with additional risk, so it’s only really worth it when a business is making decent returns from it.
Return on equity is useful for comparing the quality of different companies. Firms that can earn high returns on equity without taking on too much debt are generally of good quality. If two companies have roughly the same level of debt to equity and one has a higher ROE, I would generally prefer the one with a higher ROE.
That said, while ROE is a useful indicator of how good a business is, you’ll need to look at a whole range of factors to determine the right price to buy a stock. It is important to take into account other factors, such as future profit growth and the amount of investment required for the future. You might want to take a look at this data-rich interactive chart of the forecast for the business.
If you would rather consult with another company – one with potentially superior finances – then don’t miss this free list of interesting companies, which have a HIGH return on equity and low leverage.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.
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