Although some investors are already familiar with financial metrics (hat tip), this article is for those who would like to learn about Return On Equity (ROE) and why it is important. Through study and practice, we will look at ROE to better understand Tenet Healthcare Corporation (NYSE:THC).
Return on equity or ROE is an important way to evaluate how well a company’s management is using the company’s capital. Simply put, ROE shows how much profit each dollar generates relative to the value of the shares.
Check out our recent review of Tenet Healthcare
How Do You Calculate Return on Equity?
The return on equity formula and:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders’ Equity
Therefore, based on the above formula, Tenet Healthcare’s ROE is:
45% = US$3.5b ÷ US$7.9b (Based on the trailing twelve months to June 2024).
‘Return’ is the profit for the last twelve months. One way to think about this is that for every $1 in earnings, the company made $0.45 in profit.
When does Tenet Healthcare pay dividends?
Arguably the easiest way to evaluate a company’s ROE is to compare it to its industry average. Importantly, this is not a perfect measure, as companies vary widely within the same industry group. As can be seen in the chart below, Tenet Healthcare has a better ROE than the average (13%) in the Healthcare industry.
That’s pretty clear. However, keep in mind that a high ROE does not necessarily mean making a profit. Especially if a company is using a lot of debt to pay off its debts that can increase its ROE but a large amount puts the company at risk. Our risk dashboard should contain the 4 threats we have identified for Tenet Healthcare.
How Does Debt Affect ROE?
Most companies need money – from somewhere – to grow their profits. The money can come from retained earnings, issuing new shares (equity), or debt. In the first and second cases, ROE will show the use of these funds for the sale of the business. At the end of the day, using a loan can help you pay back, but it won’t change the money. This will make the ROE look better than if no debt was used.
Tenet Healthcare’s Debt Consolidation And Its 45% Return On Equity
Tenet Healthcare uses multiple loans to increase returns. It has a debt to equity ratio of 1.60. While its ROE is undoubtedly good, we would have been more impressed if the company had done this with less debt. Investors should think carefully about how a company would react if it could not borrow easily, because credit markets change over time.
Summary
Return on equity is a useful indicator of a business’s ability to generate profit and return to shareholders. In our books, the top companies have the highest financial returns, despite having the least amount of debt. If two companies have the same debt, and one has a higher ROE, I prefer the one with the higher ROE.
Having said that, although ROE is a useful indicator of a business, you need to look at a number of factors to determine the right price to buy a stock. The rate at which profits can grow, compared to the expectations of profit growth reflected in the current price, should also be considered. So you may want to look at industry forecasts that have more data.
Where Tenet Healthcare may not be a good buy. Then you might want to check this out free gathering other companies with high ROE and low debt.
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This article by Simply Wall St is more general in nature. We provide reviews based on historical data and expert forecasts using unbiased methods and our articles are not intended to be financial advice. It does not make recommendations to buy or sell any stock, and does not take into account your goals, or your financial situation. We want to bring you long-term analytics driven by meaningful data. Note that our analysis may not reflect the latest company announcements or stock prices. Simply Wall St does not have a position in any of the listed stocks.
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