Stock Analysis

Why Dave & Buster's Entertainment, Inc. (NASDAQ:PLAY) Looks Like A Quality Company

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NasdaqGS:PLAY
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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 Dave & Buster's Entertainment, Inc. (NASDAQ:PLAY), 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.

Check out the opportunities and risks within the US Hospitality industry.

How Is ROE Calculated?

Return on equity 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 Dave & Buster's Entertainment is:

34% = US$124m ÷ US$361m (Based on the trailing twelve months to October 2022).

The 'return' is the amount earned after tax 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 $0.34 in profit.

Does Dave & Buster's Entertainment Have A Good Return On Equity?

Arguably the easiest way to assess company's ROE is to compare it with the average in its industry. However, this method is only useful as a rough check, because companies do differ quite a bit within the same industry classification. As you can see in the graphic below, Dave & Buster's Entertainment has a higher ROE than the average (23%) in the Hospitality industry.

roe
NasdaqGS:PLAY Return on Equity December 8th 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 .

The Importance Of Debt To Return On Equity

Most companies need money -- from somewhere -- to grow their profits. The cash for investment can come from prior year profits (retained earnings), issuing new shares, or borrowing. 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. Thus the use of debt can improve ROE, albeit along with extra risk in the case of stormy weather, metaphorically speaking.

Dave & Buster's Entertainment's Debt And Its 34% ROE

We think Dave & Buster's Entertainment uses a significant amount of debt to maximize its returns, as it has a significantly higher debt to equity ratio of 3.40. Its ROE is clearly quite good, but it seems to be boosted by the significant use of debt by the company.

Conclusion

Return on equity is one way we can compare its business quality of different companies. 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 check this FREE visualization of analyst forecasts for the company.

Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of interesting companies.

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Find out whether Dave & Buster's Entertainment is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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