Is Palfinger AG (VIE:PAL) 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. Through learning-by-doing, we will examine ROE to better understand Palfinger AG (VIE:PAL).

Return on Equity or ROE is a test of how effectively a company increases its value and manages investors’ money. In other words, it reveals the company’s success in turning shareholders’ investments into profits.

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How do you calculate return on equity?

ROE can be calculated using the formula:

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

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

14% = €98m ÷ €685m (based on the last twelve months until June 2022).

“Yield” refers to a company’s earnings over the past year. Another way to think about this is that for every $1 of equity, the company was able to make a profit of $0.14.

Does Palfinger have a good ROE?

A simple way to determine if a company has a good return on equity is to compare it to the average for its industry. The limitation of this approach is that some companies are very different from others, even within the same industrial classification. As the image below clearly shows, Palfinger has a better ROE than the average (12%) in the machinery industry.

WBAG:PAL Return on Equity September 23, 2022

That’s what we like 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 a high ROE, where high debt levels could be a huge risk. Our risk dashboard should contain the 3 risks we have identified for Palfinger.

What is the impact of debt on ROE?

Companies generally need to invest money 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 equity. So using debt can improve ROE, but with the added risk of stormy weather, metaphorically speaking.

Palfinger’s debt and its ROE of 14%

Palfinger uses a high amount of debt to increase returns. Its debt to equity ratio is 1.00. While its ROE is respectable, it’s worth bearing in mind that there’s usually a limit to the amount of debt a company can use. Debt increases risk and reduces options for the business in the future, so you generally want to see good returns using it.

Conclusion

Return on equity is a useful indicator of a company’s ability to generate profits and return them to shareholders. In our books, the highest quality companies have a high return on equity, despite low leverage. 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.

But ROE is only one piece of a larger puzzle, as high-quality companies often trade on high earnings multiples. 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.

Sure, you might find a fantastic investment by looking elsewhere. So take a look at this free list of interesting companies.

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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