Many investors are still learning the different ratios that can be helpful when analyzing a stock. This article is for those who want to learn more about return on equity (ROE). To keep the lesson practical, we’ll use ROE to better understand United Parcel Service, Inc. (NYSE:UPS).

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investments it receives from its shareholders. In simpler terms, it measures the profitability of a company relative to shareholders’ equity.

Check out our latest analysis for United Parcel Service

How do you calculate return on equity?

Return on equity can be calculated using the following formula:

Return on equity = Net profit (from continuing operations) ÷ Equity

Based on the above formula, the return on equity for United Parcel Service is:

31% = $5.3 billion ÷ $17 billion (based on the trailing twelve months ending June 2024).

The “return” is the income the company earned over the last year. This means that for every dollar of equity the company earned $0.31 in profit.

Does United Parcel Service have a good return on equity?

A simple way to determine if a company has a good return on equity is to compare it to the industry average. The limitation of this approach is that some companies are very different from others, even within the same industry. As you can see in the graph below, United Parcel Service has a higher return on equity than the average (14%) in the logistics industry.

That’s a good sign. However, keep in mind that a high return on equity doesn’t necessarily indicate efficient profit generation. Aside from changes in net income, a high return on equity can also be the result of high debt to equity, which indicates risk. To learn about the 3 risks we’ve identified for United Parcel Service, visit our risk dashboard for free.

Why you should consider debt when looking at ROE

Companies usually need to invest money to increase their profits. The money for the investments can come from previous year’s profits (retained earnings), issuing new stock, or borrowing. In the first and second cases, the return on equity reflects this use of cash to invest in the company. In the second case, the use of debt improves the return but does not change the equity. In this way, the use of debt increases the return on equity even if the core economics of the company remain the same.

United Parcel Service’s debt and its 31% return on equity

United Parcel Service actually takes on a lot of debt to boost returns. Its debt-to-equity ratio is 1.28. While the return on equity is undoubtedly impressive, we would have been even more impressed if the company had achieved this with less debt. Debt brings additional risk, so it’s only really worth it if a company is generating decent returns with it.

The story continues

Summary

Return on equity is a useful indicator of a company’s ability to generate profits and distribute them to shareholders. A company that can generate a high return on equity without any debt could be considered a high-quality company. If two companies have the same return on equity, I would generally prefer the company with the lower debt.

However, if a company is of high quality, the market will often bid it up at a price that reflects this. It is particularly important to consider earnings growth rates compared to expectations reflected in the share price, so you may want to take a look at this data-rich interactive chart showing forecasts for the company.

Naturally, If you look elsewhere, you may find a fantastic investment. So take a look at the free List of interesting companies.

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This Simply Wall St article is of a general nature. We comment solely on the basis of historical data and analyst forecasts, using an unbiased methodology. Our articles do not constitute financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Simply Wall St does not hold any of the stocks mentioned.