Question

You're comparing two companies: Rayburn and Telford and observe these ratios.

	Rayburn	Telford
ROE	27%	30%
PEG	1.4	1.4
P/E	17	24
ROS	7%	7%
Total Assets/Equity	6	3
EBIT / Interest	4	8

1. What's the reason for Telford's higher ROE? Is this good thing or a bad thing?

1. Which stock would you invest in? Why?

Answer 1

Return on Equity (ROE) = Net Income/Equity

Telford has a higher ROE of 30% as compared to that of Rayburn (27%) even though the return on sales is the same for both the companies (7%). This indicates that Telford is operationally efficient and has lower debt.

Interest coverage ratio (EBIT/Interest) of Telford is twice that of Rayburn, which indicates that Telford is in a better position to pay off its interest from operating cash flows as compared to Rayburn.

We would invest in Telford because of its higher ROE with low leverage.

Total Assets/equity of Rayburn (6) > that of Telford (3%). This indicates Telford has a greater proportion of equity in total assets (and less debt) as compared to that of Rayburn. In other words, The debt proportion of Rayburn is more than that of Telford. Rayburn is more leveraged than Telford. Rayburn is risky!