China Biologic Products Holdings Inc (NASDAQ:CBPO) outperformed the Biotechnology industry on the basis of its ROE – producing a higher 20.70% relative to the peer average of 16.12% over the past 12 months. Superficially, this looks great since we know that CBPO has generated big profits with little equity capital; however, ROE doesn’t tell us how much CBPO has borrowed in debt. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of CBPO’s ROE. View our latest analysis for China Biologic Products Holdings
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) is a measure of China Biologic Products Holdings’s profit relative to its shareholders’ equity. An ROE of 20.70% implies $0.21 returned on every $1 invested. While a higher ROE is preferred in most cases, there are several other factors we should consider before drawing any conclusions.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is assessed against cost of equity, which is measured using the Capital Asset Pricing Model (CAPM) – but let’s not dive into the details of that today. For now, let’s just look at the cost of equity number for China Biologic Products Holdings, which is 11.32%. Since China Biologic Products Holdings’s return covers its cost in excess of 9.38%, its use of equity capital is efficient and likely to be sustainable. Simply put, China Biologic Products Holdings 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
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 China Biologic Products Holdings can make from its 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 ROE can be artificially increased through excessive borrowing, we should check China Biologic Products Holdings’s historic debt-to-equity ratio. Currently, China Biologic Products Holdings has no debt which means its returns are driven purely by equity capital. Therefore, the level of financial leverage has no impact on ROE, and the ratio is a representative measure of the efficiency of all its capital employed firm-wide.
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. China Biologic Products Holdings’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 China Biologic Products Holdings, I’ve put together three essential factors you should further examine:
- 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 China Biologic Products Holdings 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 China Biologic Products Holdings is currently mispriced by the market.
- 3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of China Biologic Products Holdings? 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.