Should You Be Worried About SmartCentres Real Estate Investment Trust’s (TSE:SRU.UN) 1.7% Return On Equity?

One of the best investments we can make is our own knowledge and skills. With that in mind, this article explains how we can use Return On Equity (ROE) to better understand a company. To anchor the lesson in practice, we’ll use ROE to better understand the SmartCentres Real Estate Investment Trust (TSE: SRU.UN).

Return on Equity, or ROE, is an important factor for a shareholder to consider as it indicates how effectively their capital is being reinvested. In other words, it’s a profitability metric that measures the return on the capital provided by the company’s shareholders.

Check out our latest analysis for SmartCentres Real Estate Investment Trust

How do you calculate the return on equity?

The Formula for the return on equity is:

Return on Equity = Net Income (from continuing operations) ÷ Equity

So, based on the formula above, the ROE for SmartCentres Real Estate Investment Trust is:

1.7% = CA $ 90 million ÷ CA $ 5.2 billion (based on the last twelve months through December 2020).

The “return” is the amount earned after tax over the past twelve months. Another possibility is that for every CA $ 1 worth of equity, the company made a profit of CA $ 0.02.

Does SmartCentres Real Estate Investment Trust have a good return on equity?

One easy way to see if a company is getting a good return on equity is to compare it to the industry average. It is important that this is far from a perfect measure, as companies differ significantly within the same industry classification. As shown in the graphic below, the SmartCentres Real Estate Investment Trust has a lower ROE than the average (8.7%) in the REITs industry classification.

TSX: SRU.UN return on equity April 8, 2021

Unfortunately, this is not ideal. However, we believe that a lower ROE could still mean a company has the ability to leverage its returns, assuming existing debt is low. When a company has a low ROE with high debt, we are cautious as the risk involved is too high. Our risk dashboard should contain the 4 risks that we have identified for SmartCentres Real Estate Investment Trust.

The importance of debt to return on equity

Companies typically need to invest money to grow their profits. This money can come from the issue of stocks, retained earnings, or debt. In the first and second cases, the ROE will reflect this use of cash to invest in the business. In the latter case, the debt required for growth will increase returns, but will not affect equity. This makes the ROE look better than if no debt were used.

Combination of SmartCentres Real Estate Investment Trust’s debt and its 1.7% return on equity

SmartCentres Real Estate Investment Trust uses high levels of debt to increase returns. It has a leverage ratio of 1.01. The ROE is quite low despite using significant debt. In our opinion, this is not a good result. Debt increases risk and reduces options for the company in the future. Hence, in general, you want to get good returns from using it.

Conclusion

Return on equity is useful for comparing the quality of different companies. On our books, top quality companies have high return on equity despite low debt. In general, if two companies have roughly the same level of debt to equity and one has a higher ROE, I would prefer the company with the higher ROE.

But when a company is of high quality, the market often offers it up to a price that reflects it. It’s important to consider other factors, such as future earnings growth – and how much investment will be required in the future. I think this might be worth checking out free Report on analyst forecast for the company.

Sure You could find a fantastic investment by looking elsewhere. So take a look at it free List of interesting companies.

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This article from Simply Wall St is of a general nature. It is not a recommendation to buy or sell stocks and does not take into account your goals or your financial situation. We want to provide you with a long-term, focused analysis based on fundamental data. Note that our analysis may not take into account the latest price sensitive company announcements or quality materials. Simply Wall St has no position in the stocks mentioned.
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