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Many investors are still learning about the various metrics that can be useful when analysing a stock. This article is for those who would like to learn about Return On Equity (ROE). To keep the lesson grounded in practicality, we'll use ROE to better understand Innergex Renewable Energy Inc. (TSE:INE).
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
View our latest analysis for Innergex Renewable Energy
How To Calculate Return On Equity?
ROE can be calculated by using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Innergex Renewable Energy is:
1.7% = CA$26m ÷ CA$1.5b (Based on the trailing twelve months to December 2024).
The 'return' is the yearly profit. One way to conceptualize this is that for each CA$1 of shareholders' capital it has, the company made CA$0.02 in profit.
Does Innergex Renewable Energy Have A Good ROE?
One simple way to determine if a company has a good return on equity is to compare it to the average for its industry. Importantly, this is far from a perfect measure, because companies differ significantly within the same industry classification. If you look at the image below, you can see Innergex Renewable Energy has a lower ROE than the average (13%) in the Renewable Energy industry classification.
That's not what we like to see. Although, we think that a lower ROE could still mean that a company has the opportunity to better its returns with the use of leverage, provided its existing debt levels are low. A high debt company having a low ROE is a different story altogether and a risky investment in our books. Our risks dashboard should have the 4 risks we have identified for Innergex Renewable Energy.
Why You Should Consider Debt When Looking At ROE
Companies usually need to invest money to grow their profits. That cash 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 the returns, but will not change the equity. Thus the use of debt can improve ROE, albeit along with extra risk in the case of stormy weather, metaphorically speaking.
Combining Innergex Renewable Energy's Debt And Its 1.7% Return On Equity
It appears that Innergex Renewable Energy makes extensive use of debt to improve its returns, because it has an alarmingly high debt to equity ratio of 4.35. The combination of a rather low ROE and high debt to equity is a negative, in our book.