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Should You Expect China Biologic Products Holdings Inc (NASDAQ:CBPO) To Continue Delivering An ROE Of 20.70%?

Ingrid Hart

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:

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

NasdaqGS:CBPO Last Perf Feb 9th 18

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.

NasdaqGS:CBPO Historical Debt Feb 9th 18

Next Steps:

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:

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.