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Many investors are still learning about the various indicators that are useful when analyzing stocks. This article is for those who want to understand return on equity (ROE). Through a learn-by-doing approach, we’ll examine ROE to better understand The ONE Group Hospitality, Inc. (NASDAQ: STKS).
Return on equity, or ROE, is a key metric used to evaluate how efficiently a company’s management is utilizing the company’s capital. Simply put, it measures a company’s profitability relative to shareholder equity.
Check out our latest analysis for ONE Group Hospitality
How is return on equity calculated?
ROE can be calculated using the following formula:
Return on equity = Net profit (from continuing operations) ÷ Shareholders’ equity
Therefore, based on the above formula, ONE Group Hospitality’s ROE is:
7.2% = $4.5 million ÷ $62 million (based on the trailing 12 months to September 2023).
“Return” refers to the company’s earnings last year. This means that for every $1 worth of shareholders’ equity, the company generated $0.07 in profit.
Is ONE Group Hospitality’s ROE good?
An easy way to determine if a company has a good ROE is to compare it to the industry average. However, this approach can only be used as a rough check because companies within the same industry classification do vary widely. As can be clearly seen from the chart below, ONE Group Hospitality’s ROE is lower than the average for the hotel industry (17%).
Unfortunately, this is not optimal. Nonetheless, we think a lower ROE could still mean the company has an opportunity to boost returns through the use of leverage, assuming its existing debt levels are low. High-debt companies with low ROEs are another story entirely and are a risky investment in our books. Our risk dashboard should contain the 3 risks we have identified for ONE Group Hospitality.
How does debt affect return on equity?
Companies often need investments to increase profits. This cash can come from retained earnings, issuing new shares (equity), or debt. In the first two cases, ROE will reflect the use of capital for growth. In the latter case, the debt needed for growth will enhance returns but not impact shareholder equity. Therefore, using debt can improve return on equity, although, metaphorically speaking, it comes with additional risk in the event of stormy weather.
ONE Group Hospitality’s debt and its 7.2% ROE
ONE Group Hospitality clearly uses a lot of debt to boost returns, with a debt to equity ratio of 1.17. The combination of a fairly low ROE and heavy use of debt isn’t particularly attractive. Investors should carefully consider how a company might perform if it couldn’t borrow so easily, because credit markets do change over time.
in conclusion
Return on equity is a useful measure of a business’s ability to generate profits and return them to shareholders. In our book, the best quality companies have higher returns on equity despite lower debt. If two companies have the same ROE, I would generally prefer the one with less debt.
That being said, while ROE is a useful indicator of the quality of a business, you have to consider a range of factors to determine the right price to buy a stock. Profit growth rates are a particularly important consideration compared to expectations reflected in stock prices. So you might want to check out this free visualization of analyst forecasts for the company.
But please note: ONE Group Hospitality May Not Be the Best Stock to Buy.So take a look at this free List of interesting companies with high return on equity and low debt.
Valuation is complex, but we’re helping to make it simple.
Find out if ONE Group Hospitality is potentially overvalued or undervalued by checking out our comprehensive analysis, which includes Fair value estimates, risks and warnings, dividends, insider trading and financial health.
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This article from Simply Wall St is general in nature. We only use unbiased methodologies to provide commentary based on historical data and analyst forecasts, and our articles are not intended to provide financial advice. It does not constitute a recommendation to buy or sell any stock and does not take into account your objectives or your financial situation. Our goal is to provide you with long-term focused analysis driven by fundamental data. Please note that our analysis may not take into account the latest price-sensitive company announcements or qualitative information. Simply Wall St has no position in any of the stocks mentioned.
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