Is AmRest Holdings SE’s (WSE:EAT) ROE of 2.0% a concern?
Many investors are still learning the different metrics that can be helpful when analyzing a stock. This article is for those who want to know more about return on equity (ROE). We will use ROE to examine AmRest Holdings SE (WSE:EAT), as a concrete example.
Return on equity or ROE is a key metric used to gauge how effectively a company’s management is using the company’s capital. In other words, it is a profitability ratio that measures the rate of return on capital contributed by the company’s shareholders.
Check out our latest analysis for AmRest Holdings
How to calculate return on equity?
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 AmRest Holdings is:
2.0% = €6.1m ÷ €302m (based on the last twelve months until September 2021).
The “return” is the annual profit. One way to conceptualize this is that for every PLN1 of share capital it has, the company has made a profit of 0.02 PLN.
Does AmRest Holdings have a good ROE?
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 very different from others, even within the same industrial classification. As shown in the graph below, AmRest Holdings has a below average ROE (4.9%) in the hospitality industry classification.
That’s not what we like to see. That being said, a low ROE is not always a bad thing, especially if the company has low debt, as it still leaves room for improvement if the company were to take on more debt. A highly leveraged company with a low ROE is a whole other story and a risky investment on our books. To learn about the 2 risks we have identified for AmRest Holdings, visit our risk dashboard for free.
Why You Should Consider Debt When Looking at ROE
Most businesses need money – from somewhere – to increase their profits. This money can come from retained earnings, issuing new stock (shares), 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, debt used for growth will enhance returns, but will not affect total equity. So using debt can improve ROE, but with the added risk of stormy weather, metaphorically speaking.
Combination of AmRest Holdings’ debt and its return on equity of 2.0%
AmRest Holdings uses a high amount of debt to increase returns. Its debt to equity ratio is 2.19. With a fairly low ROE and a significant reliance on debt, it is difficult to get enthusiastic about this activity at the moment. 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.
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. If two companies have the same ROE, I would generally prefer the one with less debt.
That said, while ROE is a useful indicator of a company’s quality, you’ll need to consider a whole host of factors to determine the right price to buy a stock. It is important to consider other factors, such as future earnings growth and the amount of investment needed in the future. You might want to take a look at this data-rich interactive chart of the company’s forecast.
Sure AmRest Holdings may not be the best stock to buy. So you might want to see this free collection of other companies that have 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.