STRATEC Biomedical AG (DB:SBS) outperformed the Healthcare Equipment industry on the basis of its ROE – producing a higher 15.06% relative to the peer average of 10.15% over the past 12 months. Superficially, this looks great since we know that SBS has generated big profits with little equity capital; however, ROE doesn’t tell us how much SBS has borrowed in debt. We’ll take a closer look today at factors like financial leverage to determine whether SBS’s ROE is actually sustainable. Check out our latest analysis for STRATEC Biomedical

What you must know about ROE

Return on Equity (ROE) weighs STRATEC Biomedical’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. 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 STRATEC Biomedical’s equity capital deployed. Its cost of equity is 8.47%. Since STRATEC Biomedical’s return covers its cost in excess of 6.59%, its use of equity capital is efficient and likely to be sustainable. Simply put, STRATEC Biomedical 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

Basically, profit margin measures how much of revenue trickles down into earnings which illustrates how efficient the business is with its cost management. The other component, asset turnover, illustrates how much revenue STRATEC Biomedical 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 STRATEC Biomedical’s debt-to-equity level. The debt-to-equity ratio currently stands at a low 38.90%, meaning the above-average ROE is due to its capacity to produce profit growth without a huge debt burden.

Next Steps:

ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. STRATEC Biomedical exhibits a strong ROE against its peers, as well as sufficient returns to cover 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.