Advertisement
Canada markets open in 5 hours 50 minutes

  • S&P/TSX

    22,011.72
    +139.76 (+0.64%)
     

  • S&P 500

    5,070.55
    +59.95 (+1.20%)
     

  • DOW

    38,503.69
    +263.71 (+0.69%)
     

  • CAD/USD

    0.7313
    -0.0008 (-0.11%)
     

  • CRUDE OIL

    83.42
    +0.06 (+0.07%)
     

  • Bitcoin CAD

    91,365.43
    +888.14 (+0.98%)
     

  • CMC Crypto 200

    1,419.47
    -4.63 (-0.33%)
     

  • GOLD FUTURES

    2,335.10
    -7.00 (-0.30%)
     

  • RUSSELL 2000

    2,002.64
    +35.17 (+1.79%)
     

  • 10-Yr Bond

    4.5980
    -0.0250 (-0.54%)
     

  • NASDAQ futures

    17,723.25
    +116.50 (+0.66%)
     

  • VOLATILITY

    15.76
    +0.07 (+0.45%)
     

  • FTSE

    8,082.85
    +38.04 (+0.47%)
     

  • NIKKEI 225

    38,460.08
    +907.92 (+2.42%)
     

  • CAD/EUR

    0.6838
    +0.0002 (+0.03%)
     

Is Rocky Mountain Liquor Inc.'s (CVE:RUM) ROE Of 69% Impressive?

Simply Wall St
·4 min read

Many investors are still learning about the various metrics that can be useful when analysing a stock. This article is for those who would like to learn about Return On Equity (ROE). We'll use ROE to examine Rocky Mountain Liquor Inc. (CVE:RUM), by way of a worked example.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Rocky Mountain Liquor

How Is ROE Calculated?

ROE 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 Rocky Mountain Liquor is:

69% = CA$4.3m ÷ CA$6.2m (Based on the trailing twelve months to June 2020).

The 'return' is the profit over the last twelve months. That means that for every CA$1 worth of shareholders' equity, the company generated CA$0.69 in profit.

Does Rocky Mountain Liquor 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. Pleasingly, Rocky Mountain Liquor has a superior ROE than the average (15%) in the Consumer Retailing industry.

roe
roe

That's clearly a positive. However, bear in mind that a high ROE doesn’t necessarily indicate efficient profit generation. Especially when a firm uses high levels of debt to finance its debt which may boost its ROE but the high leverage puts the company at risk. You can see the 4 risks we have identified for Rocky Mountain Liquor by visiting our risks dashboard for free on our platform here.

The Importance Of Debt To Return On Equity

Most companies need money -- from somewhere -- to grow their profits. The cash for investment can come from prior year profits (retained earnings), issuing new shares, or borrowing. In the case of the first and second options, the ROE will reflect this use of cash, for growth. In the latter case, the use of debt will improve the returns, but will not change the equity. Thus the use of debt can improve ROE, albeit along with extra risk in the case of stormy weather, metaphorically speaking.

Combining Rocky Mountain Liquor's Debt And Its 69% Return On Equity

It's worth noting the high use of debt by Rocky Mountain Liquor, leading to its debt to equity ratio of 1.27. There's no doubt the ROE is impressive, but it's worth keeping in mind that the metric could have been lower if the company were to reduce its debt. Investors should think carefully about how a company might perform if it was unable to borrow so easily, because credit markets do change over time.

Summary

Return on equity is useful for comparing the quality of different businesses. A company that can achieve a high return on equity without debt could be considered a high quality business. All else being equal, a higher ROE is better.

But when a business is high quality, the market often bids it up to a price that reflects this. Profit growth rates, versus the expectations reflected in the price of the stock, are a particularly important to consider. Check the past profit growth by Rocky Mountain Liquor by looking at this visualization of past earnings, revenue and cash flow.

But note: Rocky Mountain Liquor may not be the best stock to buy. So take a peek at this free list of interesting companies with high ROE and low debt.

This article by Simply Wall St is general in nature. 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.