Stock Analysis

Should You Be Impressed By CDW Corporation's (NASDAQ:CDW) ROE?

Published
NasdaqGS:CDW
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. To keep the lesson grounded in practicality, we'll use ROE to better understand CDW Corporation (NASDAQ:CDW).

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 the opportunities and risks within the US Electronic industry.

How To Calculate Return On Equity?

ROE 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 CDW is:

79% = US$1.0b ÷ US$1.3b (Based on the trailing twelve months to September 2022).

The 'return' is the yearly profit. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.79.

Does CDW 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. 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, CDW has a higher ROE than the average (14%) in the Electronic industry.

roe
NasdaqGS:CDW Return on Equity December 1st 2022

That's clearly a positive. Bear in mind, a high ROE doesn't always mean superior financial performance. 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 .

Why You Should Consider Debt When Looking At ROE

Most companies need money -- from somewhere -- to grow their profits. That cash can come from retained earnings, issuing new shares (equity), or debt. In the first two cases, the ROE will capture this use of capital to grow. In the latter case, the debt required for growth will boost returns, but will not impact the shareholders' equity. In this manner the use of debt will boost ROE, even though the core economics of the business stay the same.

CDW's Debt And Its 79% ROE

It appears that CDW makes extensive use of debt to improve its returns, because it has an alarmingly high debt to equity ratio of 5.00. So although the company has an impressive ROE, the company might not have been able to achieve this without the significant use of debt.

Conclusion

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. 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.

But when a business is high quality, the market often bids it up to a price that reflects this. It is important to consider other factors, such as future profit growth -- and how much investment is required going forward. So I think it may be worth checking this free report on analyst forecasts for the company.

Of course CDW 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 CDW 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.

View the Free Analysis