Should You Expect Avadel Pharmaceuticals plc (NASDAQ:AVDL) To Continue Delivering An ROE Of 34.61%?
This analysis is intended to introduce important early concepts to people who are starting to invest and looking to gauge the potential return on investment in Avadel Pharmaceuticals plc (NASDAQ:AVDL).
Avadel Pharmaceuticals plc (NASDAQ:AVDL) delivered an ROE of 34.61% over the past 12 months, which is an impressive feat relative to its industry average of 11.81% during the same period. Superficially, this looks great since we know that AVDL has generated big profits with little equity capital; however, ROE doesn’t tell us how much AVDL has borrowed in debt. We’ll take a closer look today at factors like financial leverage to determine whether AVDL’s ROE is actually sustainable. View out our latest analysis for Avadel Pharmaceuticals
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) is a measure of Avadel Pharmaceuticals’s profit relative to its shareholders’ equity. An ROE of 34.61% implies $0.35 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
ROE is measured against cost of equity in order to determine the efficiency of Avadel Pharmaceuticals’s equity capital deployed. Its cost of equity is 8.70%. Given a positive discrepancy of 25.90% between return and cost, this indicates that Avadel Pharmaceuticals pays less for its capital than what it generates in return, which is a sign of capital efficiency. 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
Basically, profit margin measures how much of revenue trickles down into earnings which illustrates how efficient the business is with its cost management. Asset turnover reveals how much revenue can be generated from Avadel Pharmaceuticals’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 Avadel Pharmaceuticals currently has. The debt-to-equity ratio currently stands at a balanced 128.47%, meaning the above-average ROE is due to its capacity to produce profit growth without a huge debt burden.
Next Steps:
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Avadel Pharmaceuticals’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 Avadel Pharmaceuticals, I’ve compiled three pertinent factors 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.
Future Earnings: How does Avadel Pharmaceuticals’s growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Avadel Pharmaceuticals? 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.
