Bioanalytical Systems Inc’s (NASDAQ:BASI) most recent return on equity was a substandard 11.10% relative to its industry performance of 11.40% over the past year. 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 BASI’s past performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of BASI’s returns. Let me show you what I mean by this. See our latest analysis for Bioanalytical Systems
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) weighs Bioanalytical Systems’s profit against the level of its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.11 in earnings from this. 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 Bioanalytical Systems’s equity capital deployed. Its cost of equity is 9.73%. Bioanalytical Systems’s ROE exceeds its cost by 1.37%, which is a big tick. Some of its peers with higher ROE may face a cost which exceeds returns, which is unsustainable and far less desirable than Bioanalytical Systems’s case of positive discrepancy. 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
Essentially, profit margin shows how much money the company makes after paying for all its expenses. Asset turnover shows how much revenue Bioanalytical Systems can generate with its current asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since ROE can be inflated by excessive debt, we need to examine Bioanalytical Systems’s debt-to-equity level. Currently the debt-to-equity ratio stands at a reasonable 54.08%, which means its ROE is driven by its ability to grow its profit without a significant debt burden.
Next Steps:
While ROE is a relatively simple calculation, it can be broken down into different ratios, each telling a different story about the strengths and weaknesses of a company. Even though Bioanalytical Systems returned below the industry average, its ROE comes in excess of its cost of equity. Its appropriate level of leverage means investors can be more confident in the sustainability of Bioanalytical Systems’s return with a possible increase should the company decide to increase its debt levels. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.