A closer look at the impressive ROE of United Utilities Group PLC (LON: UU.)
One of the best investments we can make is in our own knowledge and skills. With that in mind, this article will discuss how we can use Return on Equity (ROE) to better understand a business. We will use ROE to take a look at United Utilities Group PLC (LON: UU.), Through a real world example.
ROE or return on equity is a useful tool to assess how effectively a company can generate the returns on investment it has received from its shareholders. In simpler terms, it measures a company’s profitability relative to equity.
Check out our latest analysis for United Utilities Group
How to calculate return on equity?
The formula for ROE is:
Return on equity = Net income (from continuing operations) ÷ Equity
Thus, based on the above formula, the ROE for United Utilities Group is:
15% = £ 453 million £ 3.0 billion (based on the last twelve months to March 2021).
The “return” is the amount earned after tax over the past twelve months. One way to conceptualize this is that for every £ 1 of shareholder capital it has, the company has made £ 0.15 in profit.
Does United Utilities Group have a good return on equity?
Perhaps the easiest way to assess a company’s ROE is to compare it to the industry average. However, this method is only useful as a rough check, as companies differ a lot within a single industry classification. As shown in the image below, United Utilities Group has a better ROE than the average (12%) for the water services industry.
This is what we love to see. That said, high ROE doesn’t always indicate high profitability. A higher proportion of debt in a company’s capital structure can also result in high ROE, where high debt levels could represent a huge risk. You can see the 3 risks we have identified for United Utilities Group by visiting our risk dashboard for free on our platform here.
What is the impact of debt on return on equity?
Almost all businesses need money to invest in the business, to increase their profits. This liquidity can come from retained earnings, the issuance of new shares (shares) or debt. In the first two cases, the ROE will capture this use of capital to grow. In the latter case, the debt used for growth will improve returns, but will not affect total equity. This will make the ROE better than if no debt was used.
Combine United Utilities Group’s debt and its 15% return on equity
United Utilities Group clearly uses a high amount of debt to boost returns, as it has a debt-to-equity ratio of 2.77. While its ROE is respectable, it should be borne in mind that there is usually a limit on how much debt a business can use. Leverage increases risk and reduces options for the business in the future, so you usually want to get good returns using it.
Return on equity is a useful indicator of a company’s ability to generate profits and return them to shareholders. In our books, the highest quality companies have a high return on equity, despite low leverage. All other things being equal, a higher ROE is preferable.
That said, while ROE is a useful indicator of how good a business is, you’ll need to look at a whole range of factors to determine the right price to buy a stock. It is important to take into account other factors, such as future profit growth and the amount of investment required for the future. So I think it’s worth checking this out free analyst forecast report for the company.
But beware : United Utilities Group may not be the best stock to buy. So take a look at this free list of interesting companies with high ROE and low debt.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.
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