Yahoo Finance Can CVS Health Corporation (NYSE:CVS) Continue To Outperform Its Industry?
CVS Health Corporation (NYSE:CVS) delivered an ROE of 17.24% over the past 12 months, which is an impressive feat relative to its industry average of 13.74% during the same period. While the impressive ratio tells us that CVS has made significant profits from little equity capital, ROE doesn’t tell us if CVS has borrowed debt to make this happen. We’ll take a closer look today at factors like financial leverage to determine whether CVS’s ROE is actually sustainable. See our latest analysis for CVS Health
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) is a measure of CVS Health’s profit relative to its shareholders’ equity. An ROE of 17.24% implies $0.17 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
ROE is measured against cost of equity in order to determine the efficiency of CVS Health’s equity capital deployed. Its cost of equity is 10.30%. This means CVS Health returns enough to cover its own cost of equity, with a buffer of 6.94%. This sustainable practice implies that the company pays less for its capital than what it generates in return. ROE can be split up into three useful 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 reveals how much revenue can be generated from CVS Health’s 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 CVS Health currently has. Currently the debt-to-equity ratio stands at a high 168.30%, which means its above-average ROE is driven by significant debt levels.
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. CVS Health’s above-industry ROE is encouraging, and is also in excess of its cost of equity. With debt capital in excess of equity, ROE may be inflated by the use of debt funding, raising questions over the sustainability of the company’s returns. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For CVS Health, I’ve compiled three important factors you should look at:
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 CVS Health 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 CVS Health is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of CVS Health? 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.
