Mylan NV (NASDAQ:MYL) delivered a less impressive 6.92% ROE over the past year, compared to the 11.92% return generated by its industry. Though MYL’s recent performance is underwhelming, it is useful to understand what ROE is made up of and how it should be interpreted. Knowing these components can change your views on MYL’s below-average returns. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of MYL’s returns. Let me show you what I mean by this. View our latest analysis for Mylan
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) weighs Mylan’s profit against the level of its shareholders’ equity. An ROE of 6.92% implies $0.07 returned on every $1 invested. Generally speaking, a higher ROE is preferred; however, there are other factors we must also consider before making any conclusions.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is assessed against cost of equity, which is measured using the Capital Asset Pricing Model (CAPM) – but let’s not dive into the details of that today. For now, let’s just look at the cost of equity number for Mylan, which is 9.45%. Given a discrepancy of -2.53% between return and cost, this indicated that Mylan may be paying more for its capital than what it’s generating 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 Mylan’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 ROE can be inflated by excessive debt, we need to examine Mylan’s debt-to-equity level. The debt-to-equity ratio currently stands at a balanced 110.71%, meaning the ROE is a result of its capacity to produce profit growth without a huge debt burden.
What this means for you:
Are you a shareholder? MYL exhibits a weak ROE against its peers, as well as insufficient levels to cover its own cost of equity this year. However, investors shouldn’t despair since ROE is not inflated by excessive debt, which means MYL still has room to improve shareholder returns by raising debt to fund new investments. If you’re looking for new ideas for high-returning stocks, you should take a look at our free platform to see the list of stocks with Return on Equity over 20%.