How Did Biotage AB's (STO:BIOT) 22.80% ROE Fare Against The Industry?

With an ROE of 22.80%, Biotage AB (OM:BIOT) outpaced its own industry which delivered a less exciting 9.46% over the past year. However, whether this above-industry ROE is actually impressive depends on if it can be maintained. This can be measured by looking at the company’s financial leverage. With more debt, BIOT can invest even more and earn more money, thus pushing up its returns. However, ROE only measures returns against equity, not debt. This can be distorted, so let’s take a look at it further. Check out our latest analysis for Biotage

Breaking down ROE — the mother of all ratios

Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. For example, if the company invests SEK1 in the form of equity, it will generate SEK0.23 in earnings from this. Investors seeking to maximise their return in the Life Sciences Tools and Services industry may want to choose the highest returning stock. However, this can be misleading as each firm has different costs of equity and debt levels i.e. the more debt Biotage has, the higher ROE is pumped up in the short term, at the expense of long term interest payment burden.

Returns are usually compared to costs to measure the efficiency of capital. Biotage’s cost of equity is 8.35%. This means Biotage returns enough to cover its own cost of equity, with a buffer of 14.45%. This sustainable practice implies that the company pays less for its capital than what it generates in return. ROE can be broken down into three different ratios: net profit margin, asset turnover, and financial leverage. This is called the Dupont Formula:

Essentially, profit margin shows how much money the company makes after paying for all its expenses. Asset turnover shows how much revenue Biotage can generate with its current 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. We can determine if Biotage’s ROE is inflated by borrowing high levels of debt. Generally, a balanced capital structure means its returns will be sustainable over the long run. We can examine this by looking at Biotage’s debt-to-equity ratio. Currently, Biotage has no debt which means its returns are driven purely by equity capital. Therefore, the level of financial leverage has no impact on ROE, and the ratio is a representative measure of the efficiency of all its capital employed firm-wide.

Next Steps:

ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Biotage’s ROE is impressive relative to the industry average and also covers its cost of equity. ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of high returns. Although ROE can be a useful metric, it is only a small part of diligent research.

For Biotage, I've put together three key aspects you should look at:

• 1. 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.
• 2. Valuation: What is Biotage 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 Biotage is currently mispriced by the market.
• 3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Biotage? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!

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Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.