Is the Allegiant Travel Company’s (NASDAQ:ALGT) ROE of 3.8% a concern?
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 Allegiant Travel Company (NASDAQ: ALGT).
Return on Equity or ROE is a test of how effectively a company increases its value and manages investors’ money. In simpler terms, it measures a company’s profitability relative to equity.
How is ROE calculated?
The return on equity formula is:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the above formula, the ROE for Allegiant Travel is:
3.8% = $46 million ÷ $1.2 billion (based on trailing 12 months to June 2022).
The “yield” is the amount earned after tax over the last twelve months. Another way to think about this is that for every dollar of equity, the company was able to make a profit of $0.04.
Does Allegiant Travel have a good return on equity?
By comparing a company’s ROE with the average for its industry, we can get a quick measure of its quality. The limitation of this approach is that some companies are very different from others, even within the same industrial classification. If you look at the image below, you can see that Allegiant Travel has a below average ROE (9.0%) in the Airline industry classification.
It’s certainly not ideal. However, a low ROE is not always bad. If the company’s debt levels are moderate to low, there is always a chance that returns can be enhanced through the use of leverage. When a company has a low ROE but a high level of debt, we would be cautious because the risk involved is too high. To learn about the 4 risks we have identified for Allegiant Travel visit our risk dashboard for free.
What is the impact of debt on return on equity?
Virtually all businesses need money to invest in the business, to increase their profits. The money for the investment can come from the previous year’s earnings (retained earnings), from issuing new shares or from 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 returns, but will not change equity. So using debt can improve ROE, but with the added risk of stormy weather, metaphorically speaking.
Allegiant Travel’s debt and its ROE of 3.8%
Of note is Allegiant Travel’s heavy use of debt, which has led to its debt-to-equity ratio of 1.59. With a fairly low ROE and a significant reliance on debt, it is difficult to get enthusiastic about this activity at the moment. Debt increases risk and reduces options for the business in the future, so you generally want to see good returns using it.
Return on equity is a useful indicator of a company’s ability to generate profits and return them to shareholders. Companies that can earn high returns on equity without too much debt are generally of good quality. All things being equal, a higher ROE is better.
But ROE is only one piece of a larger puzzle, as high-quality companies often trade on high earnings multiples. The rate at which earnings are likely to grow, relative to earnings growth expectations reflected in the current price, should also be considered. So I think it’s worth checking it out free analyst forecast report for the company.
But note: Allegiant Travel 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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Find out if Allegiant Travel is potentially overvalued or undervalued by viewing our full analysis, which includes fair value estimates, risks and warnings, dividends, insider trading and financial health.
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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.