One of the best investments we can make is in our own knowledge and skills. With that in mind, this article will explain how we can use return on equity (ROE) to better understand a business. Learning by doing, we’ll look at ROE to better understand Lamar Advertising Company (NASDAQ: LAMR).
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.
See our latest analysis for Lamar Advertising
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 Lamar Advertising is:
36% = $442 million ÷ $1.2 billion (based on trailing 12 months to March 2022).
“Yield” is the income the business has earned over the past year. This means that for every dollar of shareholders’ equity, the company generated $0.36 in profit.
Does Lamar Advertising have a good return on equity?
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. Fortunately, Lamar Advertising has an above-average ROE (6.5%) for the REIT industry.
This is clearly a positive point. Keep in mind that a high ROE does not always mean superior financial performance. Besides changes in net income, a high ROE can also be the result of high debt to equity, which indicates risk. Our risk dashboard should contain the 3 risks we have identified for Lamar Advertising.
What is the impact of debt on ROE?
Companies generally need to invest money to increase their profits. The money for the investment can come from the previous year’s earnings (retained earnings), from issuing new shares or from borrowing. In the first and second case, the ROE will reflect this use of cash for investment in the business. 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 ROE of 36%
Of note is Lamar Advertising’s heavy use of debt, leading to its debt-to-equity ratio of 2.56. While there is no doubt that its ROE is impressive, we would have been even more impressed if the company had achieved this with less debt. Debt brings additional risk, so it’s only really worth it when a business is generating decent returns.
Return on equity is useful for comparing the 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 when a company is of high quality, the market often gives it a price that reflects that. 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 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.