How Cerner Corporation (NASDAQ:CERN) Delivered A Better ROE Than Its Industry
This analysis is intended to introduce important early concepts to people who are starting to invest and want to begin learning the link between company’s fundamentals and stock market performance.
With an ROE of 17.29%, Cerner Corporation (NASDAQ:CERN) outpaced its own industry which delivered a less exciting 15.32% over the past year. Superficially, this looks great since we know that CERN has generated big profits with little equity capital; however, ROE doesn’t tell us how much CERN has borrowed in debt. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of CERN’s ROE.
View our latest analysis for Cerner
Breaking down Return on Equity
Return on Equity (ROE) weighs Cerner’s profit against the level of its shareholders’ equity. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. 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
Returns are usually compared to costs to measure the efficiency of capital. Cerner’s cost of equity is 9.72%. This means Cerner returns enough to cover its own cost of equity, with a buffer of 7.57%. This sustainable practice implies that the company 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:
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. The other component, asset turnover, illustrates how much revenue Cerner can make from its asset base. Finally, financial leverage will be our main focus today. It shows how much of assets are funded by equity and can show how sustainable the company’s capital structure is. Since financial leverage can artificially inflate ROE, we need to look at how much debt Cerner currently has. At 9.04%, Cerner’s debt-to-equity ratio appears low and indicates the above-average ROE is generated from its capacity to increase profit without a large debt burden.
Next Steps:
While ROE is a relatively simple calculation, it can be broken down into different ratios, each telling a different story about the strengths and weaknesses of a company. Cerner’s ROE is impressive relative to the industry average and also covers its cost of equity. Its high ROE is not likely to be driven by high debt. Therefore, investors may have more confidence in the sustainability of this level of returns going forward. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Cerner, I’ve compiled three key aspects you should look at:
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 Cerner 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 Cerner is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Cerner? 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 past 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. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
