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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). By way of learning-by-doing, we’ll look at ROE to gain a better understanding of Hilton Grand Vacations Inc. (NYSE:HGV).
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company’s shareholders.
See our latest analysis for Hilton Grand Vacations
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 Hilton Grand Vacations is:
7.8% = US$162m ÷ US$2.1b (Based on the trailing twelve months to June 2024).
The ‘return’ refers to a company’s earnings over the last year. So, this means that for every $1 of its shareholder’s investments, the company generates a profit of $0.08.
One simple way to determine if a company has a good return on equity is to compare it to the average for its industry. The limitation of this approach is that some companies are quite different from others, even within the same industry classification. As is clear from the image below, Hilton Grand Vacations has a lower ROE than the average (17%) in the Hospitality industry.
Unfortunately, that’s sub-optimal. That being said, a low ROE is not always a bad thing, especially if the company has low leverage as this still leaves room for improvement if the company were to take on more debt. 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 3 risks we have identified for Hilton Grand Vacations.
Most companies need money — from somewhere — to grow their profits. That cash can come from retained earnings, issuing new shares (equity), or debt. In the first two cases, the ROE will capture this use of capital to grow. In the latter case, the debt required for growth will boost returns, but will not impact the shareholders’ equity. Thus the use of debt can improve ROE, albeit along with extra risk in the case of stormy weather, metaphorically speaking.
It seems that Hilton Grand Vacations uses a huge volume of debt to fund the business, since it has an extremely high debt to equity ratio of 3.18. We consider it to be a negative sign when a company has a rather low ROE despite a rather high debt to equity.