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    Should We Be Cautious About Southwest Gas Holdings, Inc.'s (NYSE:SWX) ROE Of 5.6%?

    Simply Wall St·04/14/2025 17:51:50
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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). By way of learning-by-doing, we'll look at ROE to gain a better understanding of Southwest Gas Holdings, Inc. (NYSE:SWX).

    Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

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    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 Southwest Gas Holdings is:

    5.6% = US$205m ÷ US$3.7b (Based on the trailing twelve months to December 2024).

    The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.06 in profit.

    View our latest analysis for Southwest Gas Holdings

    Does Southwest Gas Holdings Have A Good Return On Equity?

    By comparing a company's ROE with its industry average, we can get a quick measure of how good it is. The limitation of this approach is that some companies are quite different from others, even within the same industry classification. As shown in the graphic below, Southwest Gas Holdings has a lower ROE than the average (8.5%) in the Gas Utilities industry classification.

    roe
    NYSE:SWX Return on Equity April 14th 2025

    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. A company with high debt levels and low ROE is a combination we like to avoid given the risk involved.

    How Does Debt Impact ROE?

    Companies usually need to invest money to grow their 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 debt used for growth will improve returns, but won't affect the total equity. In this manner the use of debt will boost ROE, even though the core economics of the business stay the same.

    Southwest Gas Holdings' Debt And Its 5.6% ROE

    Southwest Gas Holdings clearly uses a high amount of debt to boost returns, as it has a debt to equity ratio of 1.37. The combination of a rather low ROE and significant use of debt is not particularly appealing. Debt increases risk and reduces options for the company in the future, so you generally want to see some good returns from using 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. 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 ROE is just one piece of a bigger puzzle, since high quality businesses often trade on high multiples of earnings. 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 Southwest Gas Holdings 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.