Many investors are still learning about the various metrics that can be useful when analyzing 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 T-Mobile US, Inc. (NASDAQ:TMUS).
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it receives from its shareholders. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
Check out our latest analysis for T-Mobile US
How Do You Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders’ Equity
So, based on the above formula, the ROE for T-Mobile US is:
2.2% = US$1.5b ÷ US$70b (Based on the trailing twelve months to September 2022).
The ‘return’ is the profit over the last twelve months. One way to conceptualize this is that for each $1 of shareholders’ capital it has, the company made $0.02 in profit.
Does T-Mobile US 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. 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, T-Mobile US has a lower ROE than the average (6.4%) in the Wireless Telecom industry.
That’s not what we like to see. However, a low ROE is not always bad. If the company’s debt levels are moderate to low, then there is still a chance that returns can be improved via the use of financial leverage. 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 T-Mobile US.
Why You Should Consider Debt When Looking At ROE
Companies usually need to invest money to grow their profits. The cash for investment can come from previous year profits (retained earnings), issuing new shares, or borrowing. In the first and second cases, the ROE will reflect this use of cash for investment in the business. In the latter case, the debt required for growth will boost returns, but will not affect the shareholders’ equity. Thus the use of debt can improve ROE, albeit along with extra risk in the case of stormy weather, metaphorically speaking.
T-Mobile US’ Debt And Its 2.2% ROE
T-Mobile US clearly uses a high amount of debt to boost returns, as it has a debt to equity ratio of 1.05. The combination of a rather low ROE and significant use of debt is not particularly appealing. Debt does bring extra risk, so it’s only really worthwhile when a company generates some decent returns from it.
Return on equity is useful for comparing the quality of different businesses. In our books, the highest quality companies have high return on equity, despite low debt. If two companies have the same ROE, then I would generally prefer the one with less debt.
Having said that, while ROE is a useful indicator of business quality, you’ll have to look at a whole range of factors to determine the right price to buy a stock. Profit growth rates, versus the expectations reflected in the price of the stock, are particularly important to consider. So you might want to check this FREE visualization of analyst forecasts for the company.
Of course T-Mobile US may not be the best stock to buy. So you may wish to see this free collection of other companies that have high ROE and low debt.
Do you have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take into account your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
Join A Paid User Research Session
You’ll receive a US$30 Amazon Gift card for 1 hour of your time while helping us build better investing tools for the individual investors like yourself. Sign up here