Yahoo Finance What You Must Know About CSL Limited’s (ASX:CSL) ROE
This analysis is intended to introduce important early concepts to people who are starting to invest and want to begin learning the link between CSL Limited (ASX:CSL)’s return fundamentals and stock market performance.
With an ROE of 42.11%, CSL Limited (ASX:CSL) outpaced its own industry which delivered a less exciting 17.10% over the past year. Superficially, this looks great since we know that CSL has generated big profits with little equity capital; however, ROE doesn’t tell us how much CSL has borrowed in debt. Today, we’ll take a closer look at some factors like financial leverage to see how sustainable CSL’s ROE is. See our latest analysis for CSL
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) is a measure of CSL’s profit relative to its shareholders’ equity. An ROE of 42.11% implies A$0.42 returned on every A$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
ROE is measured against cost of equity in order to determine the efficiency of CSL’s equity capital deployed. Its cost of equity is 8.55%. Since CSL’s return covers its cost in excess of 33.55%, its use of equity capital is efficient and likely to be sustainable. Simply put, CSL pays less for its capital than what it generates in return. ROE can be dissected into three distinct 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
The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. Asset turnover reveals how much revenue can be generated from CSL’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 CSL currently has. Currently the debt-to-equity ratio stands at a balanced 115.87%, which means its above-average ROE is driven by its ability to grow its profit without a significant debt burden.
Next Steps:
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. CSL’s ROE is impressive relative to the industry average and also covers its cost of equity. ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of high returns. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For CSL, there are 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.
Valuation: What is CSL 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 CSL is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of CSL? 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.
