Is Arhaus, Inc. (NASDAQ:ARHS) 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 explain how we can use return on equity (ROE) to better understand a business. We’ll use ROE to look at Arhaus, Inc. (NASDAQ:ARHS), as a concrete example.

Return on equity or ROE is a key metric used to gauge how effectively a company’s management is using the company’s capital. In other words, it reveals the company’s success in turning shareholders’ investments into profits.

Discover our latest analysis for Arhaus

How is ROE calculated?

ROE can be calculated using the formula:

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

So, based on the above formula, the ROE for Arhaus is:

53% = $37 million ÷ $70 million (based on trailing 12 months to December 2021).

“Yield” is the income the business has earned over the past year. This therefore means that for every $1 of investment by its shareholder, the company generates a profit of $0.53.

Does Arhaus 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. It is important to note that this measure is far from perfect, as companies differ significantly within the same industry classification. Fortunately, Arhaus has an ROE above the average (32%) of the specialized distribution sector.

NasdaqGS: ARHS Return on Equity April 1, 2022

It’s a good sign. 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 a high ROE, where high debt levels could be a huge risk.

What is the impact of debt on ROE?

Virtually all businesses need money to invest in the business, to increase their profits. This money can come from retained earnings, issuing new stock (shares), or debt. In the first two cases, the ROE will capture this use of capital to grow. In the latter case, the debt necessary for growth will boost returns, but will not impact shareholders’ equity. In this way, the use of debt will increase ROE, even though the core economics of the business remains the same.

Combine Arhaus’ debt and its 53% return on equity

Shareholders will be delighted to learn that Arhaus does not have an iota of net debt! Its impressive ROE suggests it’s a high-quality company, but it’s even better to have achieved this without leverage. Ultimately, when a company has zero debt, it is better positioned to seize future growth opportunities.

Summary

Return on equity is a way to compare the business quality of different companies. A company that can earn a high return on equity without going into debt could be considered a high quality company. If two companies have roughly the same level of debt and one has a higher ROE, I generally prefer the one with a higher ROE.

That said, while ROE is a useful indicator of a company’s quality, you’ll need to consider a whole host of factors to determine the right price to buy a stock. It is important to consider other factors, such as future earnings growth and the amount of investment needed in the future. You might want to take a look at this data-rich interactive chart of the company’s forecast.

But note: Arhaus 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.

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.

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