Should you be impressed by the ROE of Alliant Energy Corporation (NASDAQ:LNT)?
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. To keep the lesson grounded in practicality, we’ll use ROE to better understand Alliant Energy Corporation (NASDAQ:LNT).
Return on Equity or ROE is a test of how effectively a company increases its value and manages investors’ money. In short, ROE shows the profit that each dollar generates in relation to the investments of its shareholders.
Check out our latest analysis for Alliant Energy
How do you calculate return on equity?
Return on equity can be calculated using the formula:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the above formula, the ROE for Alliant Energy is:
11% = $680 million ÷ $6.1 billion (based on trailing 12 months to March 2022).
“Yield” is the income the business has earned over the past year. This means that for every dollar of shareholders’ equity, the company generated $0.11 in profit.
Does Alliant Energy have a good ROE?
Perhaps the easiest way to assess a company’s ROE is to compare it to the industry average. The limitation of this approach is that some companies are very different from others, even within the same industrial classification. Fortunately, Alliant Energy has an above-average ROE (9.2%) for the electric utility industry.
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. Our risk dashboard should contain the 2 risks we have identified for Alliant Energy.
What is the impact of debt on return on equity?
Companies generally need to invest money to increase their profits. This money can come from issuing shares, retained earnings or debt. 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 returns, but will not change equity. In this way, the use of debt will increase ROE, even though the core economics of the business remains the same.
Alliant Energy’s debt and its ROE of 11%
Alliant Energy is clearly using a high amount of debt to boost returns, as its debt-to-equity ratio is 1.32. With a fairly low ROE and a significant reliance on debt, it is difficult to get enthusiastic about this activity at the moment. Investors need to think carefully about how a company would perform if it weren’t able to borrow so easily, as credit markets change over time.
Return on equity is a way to compare the business quality of different companies. 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 when a company is of high quality, the market often gives it a price that reflects that. 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: Alliant Energy 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.
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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.