Boasting A 12% Return On Equity, Is Dycom Industries, Inc. (NYSE:DY) A Top Quality Stock?

While some investors are already well versed in financial metrics (hat tip), this article is for those who would like to learn about Return On Equity (ROE) and why it is important. We'll use ROE to examine Dycom Industries, Inc. (NYSE:DY), 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. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Dycom Industries

How To 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 Dycom Industries is:

12% = US$93m ÷ US$797m (Based on the trailing twelve months to July 2022).

The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.12 in profit.

Does Dycom Industries Have A Good ROE?

One simple way to determine if a company has a good return on equity is to compare it to the average for its industry. The limitation of this approach is that some companies are quite different from others, even within the same industry classification. Pleasingly, Dycom Industries has a superior ROE than the average (9.7%) in the Construction industry.

That's clearly a positive. However, bear in mind that a high ROE doesn’t necessarily indicate efficient profit generation. Especially when a firm uses high levels of debt to finance its debt which may boost its ROE but the high leverage puts the company at risk. Our risks dashboardshould have the 2 risks we have identified for Dycom Industries.

How Does Debt Impact Return On Equity?

Virtually all companies need money to invest in the business, to grow profits. The cash for investment can come from prior year profits (retained earnings), issuing new shares, or 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 debt required for growth will boost returns, but will not impact the shareholders' equity. Thus the use of debt can improve ROE, albeit along with extra risk in the case of stormy weather, metaphorically speaking.

Combining Dycom Industries' Debt And Its 12% Return On Equity

Dycom Industries clearly uses a high amount of debt to boost returns, as it has a debt to equity ratio of 1.04. The combination of a rather low ROE and significant use of debt is not particularly appealing. 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 a useful indicator of the ability of a business to generate profits and return them to shareholders. In our books, the highest quality companies have high return on equity, despite low debt. 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 take a peek at this data-rich interactive graph of forecasts for the company.

But note: Dycom Industries 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.