While some investors are already well versed in financial matters (hat tip), this article is for those who want to learn about Return On Equity (ROE) and why it is important. Through learning-by-doing, we look at ROE to gain a better understanding of Tenet Healthcare Corporation (NYSE:THC).
Return on equity or ROE is a ratio used to evaluate how well a company’s management is using the company’s capital. . In short, ROE shows the profit earned by each dollar relative to its investments.
Check out our latest analysis for Tenet Healthcare
How Do You Calculate Return on Equity?
Of the formula for return on equity of the:
Return on Equity = Income (from continuing operations) ÷ Stockholders’ equity.
So, based on the formula, the ROE for Tenet Healthcare is:
45% = US$3.5b ÷ US$7.9b (Based on 12 months ending June 2024).
The ‘return’ is the profit over the last twelve months. One way to put this into perspective is that for every $1 of shareholder capital, the company earned $0.45 in profit.
Does Tenet Healthcare have a positive ROE?
Arguably, the easiest way to evaluate a company’s ROE is to compare it to the average in its industry. Importantly, this is far from a perfect measure, because companies are very different within the classification of the same business. As the chart below shows, Tenet Healthcare has a higher ROE than the average (13%) in the Healthcare industry.
Obviously good. However, keep in mind that a high ROE does not necessarily indicate good earnings. Especially when a company uses a high level of debt to finance its debts it may increase its ROE but the high level puts the company at risk. We should have the 4 risk factors we identified for Tenet Healthcare.
How Does Debt Affect ROE?
Most companies need money – from somewhere – to grow their revenue. That cash can come from fixed income, issuing new shares (equity), or debt. In the first and second stage, the ROE will reflect this use of cash for investment in the business. In the latter case, the use of debt will improve income, but will not change equity. The ROE will be better than if no debt was used.
Tenet Healthcare Debt Consolidation and its 45% Cash Back
Tenet Healthcare uses a high amount of debt to increase revenue. It has a debt to equity ratio of 1.60. While there is no doubt that its ROE is impressive, we would have been happier if the company had achieved this under debt. Investors should think carefully about how a company will act if it is not possible to borrow something easily, because credit markets change over time.
Summary
Return on equity is a useful indicator of a business’s ability to generate profits and return them to shareholders. In our books, the top companies have the highest return on equity, despite low debt. If there are two companies with the same debt to equity ratio, and one with a higher ROE, I usually prefer the one with the higher ROE.
Having said that, although the ROE is a useful indicator of the quality of the business, you need to look at many important factors to determine the right price to buy a stock. The rate at which profits may grow, in accordance with the expectations of the growth of profits reflected in the current price, should also in his analysis. You may want to look at this information sharing information for the company.
Of course Tenet Healthcare may not be the best stock to buy. You might want to see this free collection of other companies with high ROE and low debt.
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This Simply Wall St story is general in nature. We present information based on historical data and research data only using an unbiased approach and our articles are not intended as financial advice. It is not a recommendation to buy or sell any stock, and it does not apply to your goals, or your financial situation. We aim to provide you with long-term, data-driven analytics. Note that our analysis may not be affected by new company sales promotions or specials. Simply Wall St has no position in any of the stocks mentioned.
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