Stock Analysis

What Deluxe Corporation's (NYSE:DLX) ROE Can Tell Us

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NYSE:DLX
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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. By way of learning-by-doing, we'll look at ROE to gain a better understanding of Deluxe Corporation (NYSE:DLX).

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for Deluxe

How Do You Calculate Return On Equity?

The formula for return on equity is:

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

So, based on the above formula, the ROE for Deluxe is:

11% = US$66m ÷ US$604m (Based on the trailing twelve months to December 2022).

The 'return' is the yearly profit. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.11 in profit.

Does Deluxe Have A Good ROE?

Arguably the easiest way to assess company's ROE is to compare it with the average in its industry. The limitation of this approach is that some companies are quite different from others, even within the same industry classification. The image below shows that Deluxe has an ROE that is roughly in line with the Commercial Services industry average (13%).

roe
NYSE:DLX Return on Equity March 14th 2023

So while the ROE is not exceptional, at least its acceptable. While at least the ROE is not lower than the industry, its still worth checking what role the company's debt plays as high debt levels relative to equity may also make the ROE appear high. If a company takes on too much debt, it is at higher risk of defaulting on interest payments. Our risks dashboardshould have the 3 risks we have identified for Deluxe.

Why You Should Consider Debt When Looking At ROE

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 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. Thus the use of debt can improve ROE, albeit along with extra risk in the case of stormy weather, metaphorically speaking.

Deluxe's Debt And Its 11% ROE

Deluxe clearly uses a high amount of debt to boost returns, as it has a debt to equity ratio of 2.72. The combination of a rather low ROE and significant use of debt is not particularly appealing. Debt does bring extra risk, so it's only really worthwhile when a company generates some decent returns from it.

Summary

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.

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. Profit growth rates, versus the expectations reflected in the price of the stock, are a particularly important to consider. So I think it may be worth checking this free report on analyst forecasts for the company.

But note: Deluxe 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.

What are the risks and opportunities for Deluxe?

Deluxe Corporation provides technology-enabled solutions to enterprises, small businesses, and financial institutions in the United States, Canada, Australia, South America, and Europe.

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Rewards

  • Trading at 43.4% below our estimate of its fair value

Risks

  • Earnings are forecast to decline by an average of 7.4% per year for the next 3 years

  • Interest payments are not well covered by earnings

  • Large one-off items impacting financial results

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