Should You Be Concerned About The GEO Group, Inc.'s (NYSE:GEO) ROE?

By
Simply Wall St
Published
April 20, 2022
NYSE:GEO
Source: Shutterstock

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 The GEO Group, Inc. (NYSE:GEO).

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for GEO Group

How Is ROE Calculated?

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 GEO Group is:

7.9% = US$77m ÷ US$975m (Based on the trailing twelve months to December 2021).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.08.

Does GEO Group 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, GEO Group has a lower ROE than the average (9.9%) in the Commercial Services industry.

roe
NYSE:GEO Return on Equity April 20th 2022

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. When a company has low ROE but high debt levels, we would be cautious as the risk involved is too high. To know the 2 risks we have identified for GEO Group visit our risks dashboard for free.

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 two cases, the ROE will capture this use of capital to grow. In the latter case, the debt used for growth will improve returns, but won't affect the total equity. That will make the ROE look better than if no debt was used.

Combining GEO Group's Debt And Its 7.9% Return On Equity

It appears that GEO Group makes extensive use of debt to improve its returns, because it has an alarmingly high debt to equity ratio of 3.02. We consider it to be a negative sign when a company has a rather low ROE despite a rather high debt to equity.

Summary

Return on equity is useful for comparing the quality of different businesses. A company that can achieve a high return on equity without debt could be considered a high quality business. 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 you might want to take a peek at this data-rich interactive graph of forecasts for the company.

Of course GEO Group may not be the best stock to buy. So you may wish to see this free collection of other companies that have high ROE and low debt.

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