While some investors are already familiar with financial metrics (hat trick), this article is for those who want to learn more about return on equity (ROE) and why it matters. Learning by doing, we will examine ROE to better understand The Cheesecake Factory Incorporated (NASDAQ:CAKE).
Return on Equity or ROE is a test of how effectively a company increases its value and manages investors’ money. In short, ROE shows the profit that each dollar generates in relation to the investments of its shareholders.
See our latest analysis for Cheesecake Factory
How to calculate return on equity?
the return on equity formula East:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the above formula, the ROE for Cheesecake Factory is:
22% = $72 million ÷ $330 million (based on trailing 12 months to December 2021).
“Yield” refers to a company’s earnings over the past year. This means that for every dollar of shareholders’ equity, the company generated $0.22 in profit.
Does Cheesecake Factory have a good ROE?
By comparing a company’s ROE with the average for its industry, we can get a quick measure of its quality. However, this method is only useful as a rough check, as companies differ quite a bit within the same industry classification. As you can see in the chart below, Cheesecake Factory has an above average ROE (16%) for the hospitality industry.
This is clearly a positive point. However, keep in mind that a high ROE does not necessarily indicate efficient profit generation. Especially when a company uses high levels of debt to finance its debt, which can increase its ROE, but the high leverage puts the company at risk. Our risk dashboard should contain the 3 risks we identified for Cheesecake Factory.
What is the impact of debt on return on equity?
Companies generally need to invest money to increase their profits. This money can come from issuing shares, retained earnings or debt. In the first two cases, the ROE will capture this use of capital to grow. In the latter case, debt used for growth will enhance returns, but will not affect total equity. So using debt can improve ROE, but with the added risk of stormy weather, metaphorically speaking.
Combine Cheesecake Factory’s debt and its 22% return on equity
Cheesecake Factory is clearly using a high amount of debt to boost returns, as its debt-to-equity ratio is 1.41. While its ROE is respectable, it’s worth bearing in mind that there’s usually a limit to the amount of debt a company can use. Debt increases risk and reduces options for the business in the future, so you generally want to see good returns using it.
Return on equity is a way to compare the business quality of different companies. Companies that can earn high returns on equity without too much debt are generally of good quality. If two companies have the same ROE, I would generally prefer the one with less debt.
But ROE is only one piece of a larger puzzle, as high-quality companies often trade on high earnings multiples. The rate at which earnings are likely to grow, relative to earnings growth expectations reflected in the current price, should also be considered. You might want to take a look at this data-rich interactive chart of the company’s forecast.
Sure Cheesecake Factory may not be the best stock to buy. So you might want to see this free collection of other companies that have high ROE and low debt.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.