Should We Be Happy With Ford Motor Company’s (NYSE:F) ROE of 37%?

While some investors are well versed in financial metrics (hat tip), this article is for those who want to learn about Return On Equity (ROE) and why it matters. We will use ROE to examine Ford Motor Company (NYSE:F), through a successful example.

ROE or return on equity is a useful tool for assessing how effectively a company can generate the return on investment it receives from its shareholders. In simpler terms, it measures a company’s profitability in relation to shareholder equity.

Check out our latest analysis for Ford Motor

How is ROE Calculated?

ROE can be calculated using the formula:

Return on Equity = Net Profit (from continuing operations) Shareholders’ Equity

So, based on the above formula, the ROE for Ford Motor is:

37% = US$18 billion US$49 billion (Based on the last twelve months to December 2021).

The ‘return’ is the annual profit. That means that for every $1 of shareholder equity, the company makes a profit of $0.37.

Does Ford Motor Have a Good ROE?

One simple way to determine if a company has a good return on equity is to compare it to its industry average. Importantly, this is far from a perfect measure, as companies differ significantly within the same industry classification. As is clear from the image below, Ford Motor has a better than average ROE (28%) in the automotive industry.

NYSE:F Return of Equity April 4, 2022

That’s definitely positive. Remember, high ROE does not necessarily mean superior financial performance. Apart from changes in net income, high ROE can also be caused by high debt relative to equity, which indicates risk. You can view the 5 risks we have identified for Ford Motor by visiting us risk dashboard free on our platform here.

The Importance of Debt To Restore Equity

Most companies need money — from somewhere — to increase their profits. The cash can come from the issuance of shares, retained earnings, or debt. In the case of the first and second options, the ROE will reflect the use of this cash, for growth. In the latter case, the debt required for growth will increase returns, but will have no impact on shareholder equity. Thus the use of debt can increase ROE, albeit along with the extra risk in the case of stormy weather, metaphorically.

Ford Motor’s Debt And Its 37% ROE

It should be noted that Ford Motor’s high use of debt resulted in a debt-to-equity ratio of 2.83. No doubt the ROE is impressive, but keep in mind that the metric could be lower if the company wants to reduce its debt. Debt does carry extra risk, so it’s only really worthwhile when a company generates some decent returns from it.

Conclusion

Return on equity is useful for comparing the qualities of different businesses. Companies that can achieve high returns on equity without too much debt are generally of good quality. All the same, higher ROE is better.

Therefore, while ROE is a useful indicator of business quality, you should look at a variety of factors to determine the right price to buy a stock at. The rate of profit growth, relative to the expected profit growth reflected in current prices, should also be considered. So you might want to check out this FREE visualization of analyst forecasts for companies.

If you’d rather check out other companies — companies with financially superior potential — then don’t miss this one Free a list of attractive companies, which have HIGH returns on equity and low debt.

This article from Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts using only an unbiased methodology and our article is not intended as financial advice. This does not constitute a recommendation to buy or sell any stock, and does not take into account your goals, or your financial situation. We aim to provide you with long-term focused analysis driven by fundamental data. Note that our analysis may not account for price-sensitive company announcements or recent qualitative material. Simply Wall St has no positions in any of the stocks mentioned.

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