Innovative Industrial Properties, Inc. (NYSE:IIPR) Delivered A Weaker ROE Than Its Industry

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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 Innovative Industrial Properties, Inc. (NYSE:IIPR).

Over the last twelve months Innovative Industrial Properties has recorded a ROE of 3.3%. Another way to think of that is that for every $1 worth of equity in the company, it was able to earn $0.033.

View our latest analysis for Innovative Industrial Properties

How Do I Calculate ROE?

The formula for return on equity is:

Return on Equity = Net Profit ÷ Shareholders’ Equity

Or for Innovative Industrial Properties:

3.3% = 3.435 ÷ US$151m (Based on the trailing twelve months to September 2018.)

Most readers would understand what net profit is, but it’s worth explaining the concept of shareholders’ equity. It is all earnings retained by the company, plus any capital paid in by shareholders. Shareholders’ equity can be calculated by subtracting the total liabilities of the company from the total assets of the company.

What Does ROE Mean?

Return on Equity measures a company’s profitability against the profit it has kept for the business (plus any capital injections). The ‘return’ is the yearly profit. A higher profit will lead to a higher ROE. So, as a general rule, a high ROE is a good thing. Clearly, then, one can use ROE to compare different companies.

Does Innovative Industrial Properties 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. If you look at the image below, you can see Innovative Industrial Properties has a lower ROE than the average (6.9%) in the REITs industry classification.

That certainly isn’t ideal. We’d prefer see an ROE above the industry average, but it might not matter if the company is undervalued. Still, shareholders might want to check if insiders have been selling.

How Does Debt Impact 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 required for growth will boost returns, but will not impact the shareholders’ equity. That will make the ROE look better than if no debt was used.

Innovative Industrial Properties’s Debt And Its 3.3% ROE

One positive for shareholders is that Innovative Industrial Properties does not have any net debt! Without a doubt it has a fairly low ROE, but that isn’t so bad when you consider it has no debt. After all, when a company has a strong balance sheet, it can often find ways to invest in growth, even if it takes some time.

In Summary

Return on equity is useful for comparing the quality of different businesses. In my book 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.