Sinovac Biotech Ltd (NASDAQ:SVA) generated a below-average return on equity of 18.01% in the past 12 months, while its industry returned 18.11%. An investor may attribute an inferior ROE to a relatively inefficient performance, and whilst this can often be the case, knowing the nuts and bolts of the ROE calculation may change that perspective and give you a deeper insight into SVA’s past performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of SVA’s returns. Let me show you what I mean by this. View our latest analysis for Sinovac Biotech
Breaking down Return on Equity
Return on Equity (ROE) is a measure of Sinovac Biotech’s profit relative to its shareholders’ equity. An ROE of 18.01% implies $0.18 returned on every $1 invested. 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. Sinovac Biotech’s cost of equity is 11.66%. Some of Sinovac Biotech’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 Sinovac Biotech 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:
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. Asset turnover shows how much revenue Sinovac Biotech can generate with its current asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since financial leverage can artificially inflate ROE, we need to look at how much debt Sinovac Biotech currently has. The debt-to-equity ratio currently stands at a low 24.41%, meaning Sinovac Biotech still has headroom to borrow debt to increase profits.
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Even though Sinovac Biotech 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 Sinovac Biotech, I’ve put together three important factors you should further research:
- 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 Sinovac Biotech’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 Sinovac Biotech? 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.