With a 10% return on equity, did the management of Hawaiian Electric Industries, Inc. (NYSE: HE) fare well?
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 Hawaiian Electric Industries, Inc. (NYSE: HE), using a real-world example.
Return on equity or ROE is a key metric used to assess the efficiency with which the management of a business is using business capital. In simpler terms, it measures a company’s profitability relative to equity.
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 Hawaiian Electric Industries is:
10% = US $ 244 million ÷ US $ 2.4 billion (based on the last twelve months to June 2021).
The “return” is the amount earned after tax over the past twelve months. Another way of thinking is that for every dollar of equity, the company was able to make $ 0.10 in profit.
Do Hawaiian Power Industries Have a Good ROE?
By comparing a company’s ROE with its industry average, we can get a quick measure of its quality. It is important to note that this measure is far from perfect, as companies differ considerably within a single industry classification. If you look at the image below, you can see that Hawaiian Electric Industries has an ROE similar to the Electric Utilities industry classification average (10%).
NYSE: HE Return on Equity September 11, 2021
It’s no wonder, but it’s respectable. Although the ROE is similar to that of the industry, we still need to perform additional checks to see if the company’s ROE is being boosted by high levels of debt. If so, it increases their exposure to financial risk.
What is the impact of debt on 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 two cases, the ROE will capture this use of capital to grow. In the latter case, the use of debt will improve returns, but will not affect equity. This will make the ROE better than if no debt was used.
Combine Hawaiian Electric Industries Debt and 10% Return on Equity
Hawaiian Electric Industries clearly uses a high amount of debt to boost returns, as it has a debt-to-equity ratio of 1.03. Its ROE is quite low, even with significant recourse to debt; this is not a good result, in our opinion. Leverage increases risk and reduces options for the business in the future, so you usually want to get good returns using 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 the same ROE, then I would generally prefer the one with the least amount of debt.
But ROE is only one piece of a bigger puzzle, as high-quality companies often trade at high earnings multiples. 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 take a look at this data-rich interactive chart of the forecast for the business.
Sure, you might find a fantastic investment looking elsewhere. So take a look at this free list of interesting companies.
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