Does Xcel Energy Inc. (NASDAQ: XEL) Create Shareholder Value?
Many investors are still educating themselves about the various metrics that can be useful when analyzing a stock. This article is for those who want to learn more about return on equity (ROE). We’ll use the ROE to take a look at Xcel Energy Inc. (NASDAQ: XEL), using a real-world example.
Return on equity or ROE is a key metric used to assess the efficiency with which the management of a business is using business capital. Simply put, it is used to assess a company’s profitability against its equity.
Check out our latest review for Xcel Energy
How is the ROE calculated?
The return on equity formula is:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the above formula, Xcel Energy’s ROE is:
10% = US $ 1.6 billion ÷ US $ 15 billion (based on the last twelve months to September 2021).
The “return” is the annual profit. Another way to look at this is that for every dollar in equity, the company was able to make $ 0.10 in profit.
Does Xcel Energy have a good return on equity?
By comparing a company’s ROE with its industry average, we can get a quick measure of its quality. It is important to note that this measure is far from perfect, as companies differ considerably within a single industry classification. You can see in the graph below that Xcel Energy has an ROE fairly close to the electric utility industry average (9.5%).
It is neither particularly good nor bad. Even though the ROE is respectable compared to the industry, it is worth checking out if the company’s ROE is helped by high debt levels. If so, it increases their exposure to financial risk. You can see the 2 risks we have identified for Xcel Energy by visiting our risk dashboard for free on our platform here.
The importance of debt to return on equity
Businesses generally need to invest money to increase their profits. This liquidity can come from retained earnings, the issuance of new shares (equity) 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 necessary for growth will increase returns, but will have no impact on equity. So, using debt can improve ROE, but with added risk in stormy weather, metaphorically speaking.
Combine Xcel Energy’s debt and its 10% return on equity
Xcel Energy clearly uses a high amount of debt to boost returns, as it has a debt-to-equity ratio of 1.54. The combination of a rather low ROE and a high recourse to debt is not particularly attractive. Debt comes with additional risk, so it’s only really worth it when a business is making decent returns from it.
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 the same ROE, I would generally prefer the one with the least amount of debt.
But ROE is only one piece of a bigger puzzle, as high-quality companies often trade at high earnings multiples. Especially important to consider are the growth rates of earnings, relative to expectations reflected in the stock price. So I think it’s worth checking this out free analyst forecast report for the company.
Sure, you might find a fantastic investment looking elsewhere. So take a look at this free list of interesting companies.
Do you have any feedback on this item? Are you worried about the content? Get in touch with us directly. You can also send an email to the editorial team (at) simplywallst.com.
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 shares 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.