Is American Axle & Manufacturing Holdings, Inc. (NYSE: AXL) a high quality stock to own?
One of the best investments we can make is in our own knowledge and skills. With that in mind, this article will discuss how we can use Return on Equity (ROE) to better understand a business. We’ll use ROE to take a look at American Axle & Manufacturing Holdings, Inc. (NYSE: AXL), using a real-world example.
Return on equity or ROE is an important factor for a shareholder to consider, as it tells them how efficiently their capital is being reinvested. In short, the ROE shows the profit that each dollar generates compared to the investments of its shareholders.
Check out our latest analysis for American Axle & Manufacturing Holdings
How do you calculate return on equity?
the formula for ROE is:
Return on equity = Net income (from continuing operations) Ã· Equity
So, based on the above formula, the ROE for American Axle & Manufacturing Holdings is:
20% = US $ 88 million Ã· US $ 433 million (based on the last twelve months to September 2021).
“Return” refers to a company’s profits over the past year. This means that for every dollar in shareholders’ equity, the company generated $ 0.20 in profit.
Does American Axle & Manufacturing Holdings have a good return on equity?
An easy way to determine if a company has a good return on equity is to compare it to the average in its industry. It is important to note that this measure is far from perfect, as companies differ considerably within a single industry classification. As shown in the image below, American Axle & Manufacturing Holdings has a better ROE than the automotive components industry average (13%).
This is what we love to see. However, keep in mind that a high ROE does not necessarily indicate efficient profit generation. A higher proportion of debt in a company’s capital structure can also result in high ROE, where high debt levels could represent a huge risk. To learn about the 2 risks we have identified for American Axle & Manufacturing Holdings, visit our free risk dashboard.
What is the impact of debt on ROE?
Businesses generally need to invest money to increase their profits. This liquidity can come from the issuance of shares, retained earnings or debt. In the first and second cases, the ROE will reflect this use of cash for investing in the business. In the latter case, the debt used for growth will improve returns, but will not affect total equity. In this way, the use of debt will increase the ROE, even if the basic economy of the business remains the same.
Combine the debt of American Axle & Manufacturing Holdings and its 20% return on equity
It appears that American Axle & Manufacturing Holdings is using debt extensively to improve its returns, as its debt-to-equity ratio is an alarming 7.28. His ROE is decent, but once I consider all the debt I’m not really impressed.
Return on equity is a useful indicator of a company’s ability to generate profits and return them to shareholders. A business that can earn a high return on equity without going into debt can be considered a high quality business. If two companies have roughly the same level of debt to equity and one has a higher ROE, I would generally prefer the one with a higher ROE.
That said, while ROE is a useful indicator of how good a business is, you’ll need to look at a whole range of factors to determine the right price to buy a stock. The rate at which earnings are likely to grow, relative to earnings growth expectations reflected in the current price, should also be taken into account. So you might want to check out this FREE visualization of analyst forecasts for the business.
But beware : American Axle & Manufacturing Holdings may not be the best stock to buy. So take a look at this free list of interesting companies with 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 using only 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 goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.