Can Celgene Corporation (CELG) Continue To Outperform Its Industry?

Over the past 12 months, Celgene Corporation (NASDAQ:CELG) generated an ROE of 33.6%, implying the company created 33.6 cents on every dollar of shareholders’ invested capital. While Celgene turned out to be more efficient than its industry, which delivered a Return on Equity of 29.61%, there are other factors to consider before we call it superior. See our latest analysis for CELG

Breaking down Return on Equity

ROE ratio basically calculates the net income as a percentage of total capital committed by shareholders, namely shareholders’ equity.Generally, an ROE of 20% or more is considered highly attractive for any investment consideration. Although, it’s more of an industry-specific ratio as the constituents share similar risk profile.

Return on Equity = Net Profit ÷ Shareholders Equity

ROE above the cost of equity estimate indicates value creation, which apparently is the only reason shares rally. The cost of equity can be estimated through a popular and Nobel-prize winning method called Capital Asset Pricing Model (CAPM). With a few sets of assumptions, the CAPM pegs CELG’s cost of equity at 14.32%, compared to its ROE of 33.6%.

Celgene (NasdaqGS:CELG) Last Perf Jun 14th 17
Celgene (NasdaqGS:CELG) Last Perf Jun 14th 17
ROE can be broken down into three ratios using the Dupont formula. The profit margin is the income as a percentage of sales, while asset turnover highlights how efficiently a company is using the resources at its disposal. Increased leverage, primarily through raising debt, is good for a profitable company, but only to the extent it doesn’t make the firm insolvent in a time of crisis.

Dupont Formula

ROE = annual net profit ÷ shareholders’ equity

ROE = (annual net profit ÷ sales) × (sales ÷ assets) × (assets ÷ shareholders’ equity)

ROE = profit margin × asset turnover × financial leverage

A reflection of how net profit margin has affected ROE in the past can be seen in the trend of income and revenue. An investor can gauge a fair estimate of how it’s going to play out in the future by looking at the analysts’ forecasts in the years ahead.The asset turnover for a capital intensive industry such as bricks-and-mortar retail would be substantially lower than the e-commerce retail industry. A comparison with the industry can be drawn through ROA, which represents earnings as a percentage of assets. Celgene’s ROA stood at 8.3% in the past year, compared to the industry’s 8.92%.

Celgene (NasdaqGS:CELG) Historical Debt Jun 14th 17
Celgene (NasdaqGS:CELG) Historical Debt Jun 14th 17

We can assess whether CELG is fuelling ROE by excessively raising debt or if it has a balanced capital structure by looking at the historic debt-equity trend of the company. While Celgene’s debt to equity ratio currently stands at 1.87, investors should assess how it has changed over the past few years. To account for leverage, we should look at CELG’s Return on capital, which stood at 12% in the past year versus industry’s -33.5%. ROC is earnings as a percentage of overall employed capital compared to just equity as in the case of ROE.

ROE – More than just a profitability ratio

While ROE can be calculated through a very simple calculation, investors should look at various ratios by breaking it down and how each of them affects the return to understand the strengths and weakness of a company. It’s one of the few ratios which stitches together performance metrics from the income statement and the balance sheet. What are the analysts’ projection of Celgene’s ROE in three years? I recommend you see our latest FREE analysis report to find out!

If you are not interested in CELG anymore, you can use our free platform to see my list of stocks with Return on Equity over 20%.