Jazz Pharmaceuticals Public Limited Company (NASDAQ:JAZZ) delivered an ROE of 17.79% over the past 12 months, which is an impressive feat relative to its industry average of 11.92% during the same period. While the impressive ratio tells us that JAZZ has made significant profits from little equity capital, ROE doesn’t tell us if JAZZ has borrowed debt to make this happen. We’ll take a closer look today at factors like financial leverage to determine whether JAZZ’s ROE is actually sustainable. View our latest analysis for Jazz Pharmaceuticals
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) weighs Jazz Pharmaceuticals’s profit against the level of its shareholders’ equity. An ROE of 17.79% implies $0.18 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
Returns are usually compared to costs to measure the efficiency of capital. Jazz Pharmaceuticals’s cost of equity is 8.49%. This means Jazz Pharmaceuticals returns enough to cover its own cost of equity, with a buffer of 9.30%. 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 shows how much revenue Jazz Pharmaceuticals 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 artificially increased through excessive borrowing, we should check Jazz Pharmaceuticals’s historic debt-to-equity ratio. The debt-to-equity ratio currently stands at a sensible 63.98%, meaning the above-average ROE is due to its capacity to produce profit growth without a huge debt burden.
What this means for you:
Are you a shareholder? JAZZ exhibits a strong ROE against its peers, as well as sufficient returns to cover its cost of equity. Since ROE is not inflated by excessive debt, it might be a good time to add more of JAZZ to your portfolio if your personal research is confirming what the ROE is telling you. 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%.