While some investors are already familiar with financial metrics (hat tip), this article is for those who want to learn more about return on equity (ROE) and why it’s important. As a learning-by-doing, we’ll take a look at the ROE to better understand Avid Bioservices, Inc. (NASDAQ: CDMO).
Return on equity or ROE is a key metric used to assess the efficiency with which the management of a business is using business capital. In other words, it is a profitability ratio that measures the rate of return on capital contributed by the shareholders of the company.
Check out our latest review for Avid Bioservices
How do you calculate return on equity?
ROE can be calculated using the formula:
Return on equity = Net income (from continuing operations) Ã· Equity
Thus, based on the above formula, the ROE of Avid Bioservices is:
14% = US $ 11 million Ã· US $ 78 million (based on the last twelve months to April 2021).
The “return” is the income the business has earned over the past year. This therefore means that for every $ 1 invested by its shareholder, the company generates a profit of $ 0.14.
Does Avid Bioservices have a good ROE?
A simple way to determine if a company has a good return on equity is to compare it to the average in its industry. It is important to note that this measure is far from perfect, as companies differ considerably within a single industry classification. You can see from the graph below that Avid Bioservices has an ROE quite close to the Biotech industry average (18%).
It is neither particularly good nor bad. Even though the ROE is respectable compared to the industry, it is worth checking out if the company’s ROE is helped by high debt levels. If a business is too indebted, it runs a greater risk of defaulting on interest. To learn about the 3 risks we have identified for Avid Bioservices, visit our free risk dashboard.
Why You Should Consider Debt When Looking At ROE
Almost all businesses need money to invest in the business, to increase their profits. The money for the investment can come from the profits of the previous year (retained earnings), from the issuance of new shares or from loans. In the first and second cases, the ROE will reflect this use of cash for investing in the business. In the latter case, the debt necessary for growth will increase returns, but will have no impact on equity. This will make the ROE better than if no debt was used.
Avid Bioservices’ debt and its ROE of 14%
Avid Bioservices uses a large amount of debt to increase returns. Its debt to equity ratio is 1.25. While his ROE is quite respectable, the amount of debt the company currently carries is not ideal. Debt comes with additional risk, so it’s only really worth it when a business is making decent returns from it.
Return on equity is a useful indicator of a company’s ability to generate profits and return them to shareholders. In our books, the highest quality companies have a high return on equity, despite low leverage. All other things being equal, a higher ROE is better.
That said, while ROE is a useful indicator of how good a business is, you’ll need to look at a whole range of factors to determine the right price to buy a stock. The rate at which earnings are likely to grow, relative to earnings growth expectations reflected in the current price, should also be considered. You might want to take a look at this data-rich interactive chart of the forecast for the business.
Sure Avid Bioservices may not be the best stock to buy. So you might want to see this free collection of other companies with high ROE and low leverage.
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