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. We’ll use ROE to look at Lamar Advertising Company (NASDAQ:LAMR), as a real-world example.
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 other words, it reveals the company’s success in turning shareholders’ investments into profits.
Check out our latest analysis for Lamar Advertising
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 Lamar Advertising is:
30% = $373 million ÷ $1.2 billion (based on trailing 12 months to September 2021).
The “yield” is the amount earned after tax over the last twelve months. This means that for every dollar of shareholders’ equity, the company generated $0.30 in profit.
Does Lamar Advertising have a good ROE?
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. Fortunately, Lamar Advertising has an above-average ROE (6.7%) for the REIT industry.
It’s a good sign. That said, a high ROE does not always mean high profitability. Besides changes in net income, a high ROE can also be the result of high debt to equity, which indicates risk. You can see the 3 risks we have identified for Lamar Advertising by visiting our risk dashboard for free on our platform here.
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 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 change equity. In this way, the use of debt will increase ROE, even though the core economics of the business remains the same.
Lamar Advertising’s debt and its 30% ROE
Of note is Lamar Advertising’s heavy use of debt, leading to its debt-to-equity ratio of 2.28. Its ROE is quite impressive, but it probably would have been lower without the use of debt. 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 a way to compare the business quality of different companies. A company that can earn a high return on equity without going into debt could be considered a high quality company. 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. 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 company’s forecast.
Sure, you might find a fantastic investment by looking elsewhere. So take a look at this free list of interesting companies.
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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.
