Should you be impressed by the ROE of Copa Holdings, SA (NYSE:CPA)?
Many investors are still learning the different metrics that can be useful when analyzing a stock. This article is for those who want to know more about return on equity (ROE). We’ll use ROE to look at Copa Holdings, SA (NYSE:CPA), as a real-life example.
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 other words, it is a profitability ratio that measures the rate of return on capital contributed by the company’s shareholders.
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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 Copa Holdings is:
21% = $270m ÷ $1.3bn (based on trailing 12 months to June 2022).
The “return” is the annual profit. Another way to think about this is that for every dollar of equity, the company was able to make a profit of $0.21.
Does Copa Holdings have a good return on equity?
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, Copa Holdings has an above-average ROE (5.5%) for the airline industry.
That’s what we like to see. That said, a high ROE does not always mean high profitability. A higher proportion of debt in a company’s capital structure can also result in a high ROE, where high debt levels could be a huge risk.
What is the impact of debt on 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 first and second case, the ROE will reflect this use of cash for investment in the business. 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.
Combine Copa Holdings debt and its 21% return on equity
Copa Holdings 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 increases risk and reduces options for the business in the future, so you generally want to see good returns using it.
Return on equity is a useful indicator of a company’s ability to generate profits and return them to shareholders. 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 when a company is of high quality, the market often gives it a price that reflects that. 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 check out this FREE analyst forecast visualization for the company.
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.