Is American Axle & Manufacturing Holdings, Inc. (NYSE:AXL) A High Quality Stock To Own?

By
Simply Wall St
Published
January 05, 2022
NYSE:AXL
Source: Shutterstock

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. We'll use ROE to examine American Axle & Manufacturing Holdings, Inc. (NYSE:AXL), by way of a worked example.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for American Axle & Manufacturing Holdings

How Do You Calculate Return On Equity?

The formula for ROE is:

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

So, based on the above formula, the ROE for American Axle & Manufacturing Holdings is:

20% = US$88m ÷ US$433m (Based on the trailing twelve months to September 2021).

The 'return' refers to a company's earnings over the last year. That means that for every $1 worth of shareholders' equity, the company generated $0.20 in profit.

Does American Axle & Manufacturing Holdings 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. Importantly, this is far from a perfect measure, because companies differ significantly within the same industry classification. As is clear from the image below, American Axle & Manufacturing Holdings has a better ROE than the average (13%) in the Auto Components industry.

roe
NYSE:AXL Return on Equity January 5th 2022

That's what we like to see. However, bear in mind that a high ROE doesn’t necessarily indicate efficient profit generation. A higher proportion of debt in a company's capital structure may also result in a high ROE, where the high debt levels could be a huge risk . To know the 2 risks we have identified for American Axle & Manufacturing Holdings visit our risks dashboard for free.

How Does Debt Impact ROE?

Companies usually need to invest money 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 debt used for growth will improve returns, but won't affect the total equity. In this manner the use of debt will boost ROE, even though the core economics of the business stay the same.

Combining American Axle & Manufacturing Holdings' Debt And Its 20% Return On Equity

It appears that American Axle & Manufacturing Holdings makes extensive use of debt to improve its returns, because it has an alarmingly high debt to equity ratio of 7.28. Its ROE is decent, but once I consider all the debt, I'm not really impressed.

Summary

Return on equity is a useful indicator of the ability of a business to generate profits and return them to shareholders. A company that can achieve a high return on equity without debt could be considered a high quality business. If two companies have around the same level of debt to equity, and one has a higher ROE, I'd generally prefer the one with higher ROE.

Having said that, while ROE is a useful indicator of business quality, you'll have to look at a whole range of factors to determine the right price to buy a stock. The rate at which profits are likely to grow, relative to the expectations of profit growth reflected in the current price, must be considered, too. So you might want to check this FREE visualization of analyst forecasts for the company.

But note: American Axle & Manufacturing Holdings 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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