Stock Analysis

Why Enphase Energy, Inc. (NASDAQ:ENPH) Looks Like A Quality Company

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NasdaqGM:ENPH
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Many investors are still learning about the various metrics that can be useful when analysing a stock. This article is for those who would like to learn about Return On Equity (ROE). To keep the lesson grounded in practicality, we'll use ROE to better understand Enphase Energy, Inc. (NASDAQ:ENPH).

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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Enphase Energy

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 Enphase Energy is:

50% = US$166m ÷ US$331m (Based on the trailing twelve months to March 2022).

The 'return' is the income the business earned over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.50.

Does Enphase Energy 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. The limitation of this approach is that some companies are quite different from others, even within the same industry classification. As is clear from the image below, Enphase Energy has a better ROE than the average (19%) in the Semiconductor industry.

roe
NasdaqGM:ENPH Return on Equity June 27th 2022

That's what we like to see. With that said, a high ROE doesn't always indicate high profitability. Aside from changes in net income, a high ROE can also be the outcome of high debt relative to equity, which indicates risk. To know the 3 risks we have identified for Enphase Energy visit our risks dashboard for free.

How Does Debt Impact Return On Equity?

Companies usually need to invest money to grow their profits. That cash can come from issuing shares, retained earnings, or debt. In the case of the first and second options, the ROE will reflect this use of cash, for growth. In the latter case, the use of debt will improve the returns, but will not change the equity. That will make the ROE look better than if no debt was used.

Combining Enphase Energy's Debt And Its 50% Return On Equity

It appears that Enphase Energy makes extensive use of debt to improve its returns, because it has an alarmingly high debt to equity ratio of 3.88. While its ROE is no doubt quite impressive, it could give a false impression about the company's returns given that its huge debt could be boosting those returns.

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 the same ROE, then I would generally prefer the one with less debt.

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. It is important to consider other factors, such as future profit growth -- and how much investment is required going forward. So you might want to take a peek at this data-rich interactive graph of forecasts for the company.

Of course Enphase Energy 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.

Valuation is complex, but we're helping make it simple.

Find out whether Enphase Energy 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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About NasdaqGM:ENPH

Enphase Energy

Enphase Energy, Inc., together with its subsidiaries, designs, develops, manufactures, and sells home energy solutions for the solar photovoltaic industry in the United States and internationally.

The Snowflake is a visual investment summary with the score of each axis being calculated by 6 checks in 5 areas.

Analysis AreaScore (0-6)
Valuation0
Future Growth6
Past Performance5
Financial Health6
Dividends0

Read more about these checks in the individual report sections or in our analysis model.

Exceptional growth potential with flawless balance sheet.