Should You Be Worried About Enlight Renewable Energy Ltd's (TLV:ENLT) 4.6% Return On Equity?

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. To keep the lesson grounded in practicality, we'll use ROE to better understand Enlight Renewable Energy Ltd (TLV:ENLT).

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.

Our free stock report includes 3 warning signs investors should be aware of before investing in Enlight Renewable Energy. Read for free now.

How Do You Calculate Return On Equity?

ROE can be calculated by using the formula:

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

So, based on the above formula, the ROE for Enlight Renewable Energy is:

4.6% = US$67m ÷ US$1.4b (Based on the trailing twelve months to December 2024).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every ₪1 worth of equity, the company was able to earn ₪0.05 in profit.

See our latest analysis for Enlight Renewable Energy

Does Enlight Renewable Energy Have A Good Return On Equity?

By comparing a company's ROE with its industry average, we can get a quick measure of how good it is. Importantly, this is far from a perfect measure, because companies differ significantly within the same industry classification. As is clear from the image below, Enlight Renewable Energy has a lower ROE than the average (8.1%) in the Renewable Energy industry.

That's not what we like to see. Although, we think that a lower ROE could still mean that a company has the opportunity to better its returns with the use of leverage, provided its existing debt levels are low. A company with high debt levels and low ROE is a combination we like to avoid given the risk involved. Our risks dashboard should have the 3 risks we have identified for Enlight Renewable Energy.

The Importance Of Debt To Return On Equity

Most companies need money -- from somewhere -- to grow their profits. That cash can come from issuing shares, retained earnings, or debt. In the first and second cases, the ROE will reflect this use of cash for investment in the business. In the latter case, the use of debt will improve the returns, but will not change the equity. That will make the ROE look better than if no debt was used.

Combining Enlight Renewable Energy's Debt And Its 4.6% Return On Equity

It's worth noting the high use of debt by Enlight Renewable Energy, leading to its debt to equity ratio of 2.02. Its ROE is quite low, even with the use of significant debt; that's not a good result, in our opinion. 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.

Conclusion

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. 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. So you might want to take a peek at this data-rich interactive graph of forecasts for the company.

But note: Enlight Renewable Energy 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.

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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.