Is AbbVie Inc’s (NYSE:ABBV) ROE Of 93.77% Sustainable?
With an ROE of 93.77%, AbbVie Inc (NYSE:ABBV) outpaced its own industry which delivered a less exciting 16.06% over the past year. While the impressive ratio tells us that ABBV has made significant profits from little equity capital, ROE doesn’t tell us if ABBV has borrowed debt to make this happen. We’ll take a closer look today at factors like financial leverage to determine whether ABBV’s ROE is actually sustainable. View our latest analysis for AbbVie
Breaking down Return on Equity
Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.94 in earnings from this. In most cases, a higher ROE is preferred; however, there are many other factors we must consider prior to making any investment decisions.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is measured against cost of equity in order to determine the efficiency of AbbVie’s equity capital deployed. Its cost of equity is 12.42%. Given a positive discrepancy of 81.36% between return and cost, this indicates that AbbVie pays less for its capital than what it generates in return, which is a sign of capital efficiency. ROE can be split up into three useful ratios: net profit margin, asset turnover, and financial leverage. This is called the Dupont Formula:
Dupont Formula
ROE = profit margin × asset turnover × financial leverage
ROE = (annual net profit ÷ sales) × (sales ÷ assets) × (assets ÷ shareholders’ equity)
ROE = annual net profit ÷ shareholders’ equity
The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. Asset turnover shows how much revenue AbbVie can generate with its current asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable the company’s capital structure is. Since financial leverage can artificially inflate ROE, we need to look at how much debt AbbVie currently has. At over 2.5 times, AbbVie’s debt-to-equity ratio is very high and indicates the above-average ROE is generated by significant leverage levels.
Next Steps:
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. AbbVie’s above-industry ROE is encouraging, and is also in excess of its cost of equity. Its high debt level means its strong ROE may be driven by debt funding which raises concerns over the sustainability of AbbVie’s returns. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For AbbVie, there are three fundamental factors you should further research:
1. Financial Health: Does it have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
2. Valuation: What is AbbVie worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether AbbVie is currently mispriced by the market.
3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of AbbVie? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.
