This analysis is intended to introduce important early concepts to people who are starting to invest and want a simplistic look at the return on Grifols SA (BME:GRF) stock.
With an ROE of 18.07%, Grifols SA (BME:GRF) outpaced its own industry which delivered a less exciting 17.10% over the past year. Superficially, this looks great since we know that GRF has generated big profits with little equity capital; however, ROE doesn’t tell us how much GRF has borrowed in debt. We’ll take a closer look today at factors like financial leverage to determine whether GRF’s ROE is actually sustainable. See our latest analysis for Grifols
What you must know about ROE
Return on Equity (ROE) weighs Grifols’s profit against the level of its shareholders’ equity. An ROE of 18.07% implies €0.18 returned on every €1 invested. Generally speaking, a higher ROE is preferred; however, there are other factors we must also consider before making any conclusions.
Return on Equity = Net Profit ÷ Shareholders Equity
Returns are usually compared to costs to measure the efficiency of capital. Grifols’s cost of equity is 8.26%. Since Grifols’s return covers its cost in excess of 9.82%, its use of equity capital is efficient and likely to be sustainable. Simply put, Grifols pays less for its capital than what it generates in return. ROE can be broken down into three different ratios: net profit margin, asset turnover, and financial leverage. This is called the 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
Essentially, profit margin shows how much money the company makes after paying for all its expenses. Asset turnover reveals how much revenue can be generated from Grifols’s 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 Grifols currently has. Currently the debt-to-equity ratio stands at a high 161.78%, which means its above-average ROE is driven by significant debt levels.
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Grifols’s above-industry ROE is encouraging, and is also in excess of its cost of equity. With debt capital in excess of equity, ROE may be inflated by the use of debt funding, raising questions over the sustainability of the company’s returns. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Grifols, I’ve put together three relevant aspects you should further examine:
- 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.
- Valuation: What is Grifols 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 Grifols is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Grifols? 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.