Advertisement
Canada markets close in 2 hours 35 minutes

  • S&P/TSX

    21,741.57
    -46.91 (-0.22%)
     

  • S&P 500

    5,464.56
    -4.74 (-0.09%)
     

  • DOW

    39,130.94
    +18.78 (+0.05%)
     

  • CAD/USD

    0.7302
    -0.0021 (-0.28%)
     

  • CRUDE OIL

    81.19
    +0.36 (+0.45%)
     

  • Bitcoin CAD

    83,451.52
    -1,036.89 (-1.23%)
     

  • CMC Crypto 200

    1,262.24
    -21.55 (-1.68%)
     

  • GOLD FUTURES

    2,313.20
    -17.60 (-0.76%)
     

  • RUSSELL 2000

    2,014.94
    -7.40 (-0.37%)
     

  • 10-Yr Bond

    4.3060
    +0.0680 (+1.61%)
     

  • NASDAQ

    17,742.31
    +24.65 (+0.14%)
     

  • VOLATILITY

    12.72
    -0.12 (-0.93%)
     

  • FTSE

    8,225.33
    -22.46 (-0.27%)
     

  • NIKKEI 225

    39,667.07
    +493.92 (+1.26%)
     

  • CAD/EUR

    0.6830
    -0.0002 (-0.03%)
     
MARKETS LIVE BLOG:

STOCKS WOBBLE AS INVESTORS ON WATCH FOR CUES

Rivian stock soars after Volkswagen says it'll invest up to US$5 billion in JV

Is Constellation Software Inc.'s (TSE:CSU) ROE Of 8.0% Concerning?

editorial-team@simplywallst.com (Simply Wall St)
·3 min read

One of the best investments we can make is in our own knowledge and skill set. With that in mind, this article will work through how we can use Return On Equity (ROE) to better understand a business. By way of learning-by-doing, we'll look at ROE to gain a better understanding of Constellation Software Inc. (TSE:CSU).

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Constellation Software

How To Calculate Return On Equity?

Return on equity can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

ADVERTISEMENT

So, based on the above formula, the ROE for Constellation Software is:

8.0% = US$219m ÷ US$2.8b (Based on the trailing twelve months to March 2024).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each CA$1 of shareholders' capital it has, the company made CA$0.08 in profit.

Does Constellation Software Have A Good Return On Equity?

One 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 quite different from others, even within the same industry classification. If you look at the image below, you can see Constellation Software has a lower ROE than the average (11%) in the Software industry classification.

roe
roe

That certainly isn't ideal. However, a low ROE is not always bad. If the company's debt levels are moderate to low, then there's still a chance that returns can be improved via the use of financial leverage. A high debt company having a low ROE is a different story altogether and a risky investment in our books. To know the 2 risks we have identified for Constellation Software visit our risks dashboard for free.

How Does Debt Impact Return On Equity?

Virtually all companies need money to invest in the business, to grow profits. That cash can come from retained earnings, issuing new shares (equity), or debt. In the first two cases, the ROE will capture this use of capital to grow. In the latter case, the debt used for growth will improve returns, but won't affect the total equity. That will make the ROE look better than if no debt was used.

Combining Constellation Software's Debt And Its 8.0% Return On Equity

Constellation Software clearly uses a high amount of debt to boost returns, as it has a debt to equity ratio of 1.43. With a fairly low ROE, and significant use of debt, it's hard to get excited about this business at the moment. Debt does bring extra risk, so it's only really worthwhile when a company generates some decent returns from it.

Summary

Return on equity is useful for comparing the quality of different businesses. In our books, the highest quality companies have high return on equity, despite low debt. If two companies have around the same level of debt to equity, and one has a higher ROE, I'd generally prefer the one with higher ROE.

Having said that, while ROE is a useful indicator of business quality, you'll have to look at a whole range of factors to determine the right price to buy a stock. The rate at which profits are likely to grow, relative to the expectations of profit growth reflected in the current price, must be considered, too. So I think it may be worth checking this free report on analyst forecasts for the company.

Of course Constellation Software may not be the best stock to buy. So you may wish to see this free collection of other companies that have high ROE and low debt.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an 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 account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com