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Why Laboratorios Farmaceuticos ROVI SA. (BME:ROVI) Delivered An Inferior ROE Compared To The Industry

Lawrence Carr

Laboratorios Farmaceuticos ROVI SA.’s (BME:ROVI) most recent return on equity was a substandard 8.91% relative to its industry performance of 11.62% over the past year. Though ROVI’s recent performance is underwhelming, it is useful to understand what ROE is made up of and how it should be interpreted. Knowing these components can change your views on ROVI’s below-average returns. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of ROVI’s returns. Let me show you what I mean by this. Check out our latest analysis for Laboratorios Farmaceuticos ROVI

Breaking down ROE — the mother of all ratios

Return on Equity (ROE) weighs Laboratorios Farmaceuticos ROVI’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. 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 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 Laboratorios Farmaceuticos ROVI, which is 8.29%. Some of Laboratorios Farmaceuticos ROVI’s peers may have a higher ROE but its cost of equity could exceed this return, leading to an unsustainable negative discrepancy i.e. the company spends more than it earns. This is not the case for Laboratorios Farmaceuticos ROVI which is reassuring. 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

BME:ROVI Last Perf May 23rd 18

Essentially, profit margin shows how much money the company makes after paying for all its expenses. The other component, asset turnover, illustrates how much revenue Laboratorios Farmaceuticos ROVI 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 inflated by excessive debt, we need to examine Laboratorios Farmaceuticos ROVI’s debt-to-equity level. The debt-to-equity ratio currently stands at a low 20.35%, meaning Laboratorios Farmaceuticos ROVI still has headroom to borrow debt to increase profits.

BME:ROVI Historical Debt May 23rd 18

Next Steps:

ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Even though Laboratorios Farmaceuticos ROVI returned below the industry average, its ROE comes in excess of its cost of equity. Also, ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of returns, which has headroom to increase further. Although ROE can be a useful metric, it is only a small part of diligent research.

For Laboratorios Farmaceuticos ROVI, there are three pertinent factors you should further research:

  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 Laboratorios Farmaceuticos ROVI 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 Laboratorios Farmaceuticos ROVI is currently mispriced by the market.
  3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Laboratorios Farmaceuticos ROVI? 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.