Stock Analysis

A Closer Look At Amneal Pharmaceuticals, Inc.'s (NYSE:AMRX) Uninspiring ROE

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NYSE:AMRX
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Many investors are still learning about the various metrics that can be useful when analysing a stock. This article is for those who would like to learn about Return On Equity (ROE). We'll use ROE to examine Amneal Pharmaceuticals, Inc. (NYSE:AMRX), by way of a worked example.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Amneal Pharmaceuticals

How To Calculate Return On Equity?

ROE can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Amneal Pharmaceuticals is:

3.0% = US$11m ÷ US$360m (Based on the trailing twelve months to September 2020).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.03 in profit.

Does Amneal Pharmaceuticals Have A Good ROE?

Arguably the easiest way to assess company's ROE is to compare it with the average in its industry. However, this method is only useful as a rough check, because companies do differ quite a bit within the same industry classification. As shown in the graphic below, Amneal Pharmaceuticals has a lower ROE than the average (17%) in the Pharmaceuticals industry classification.

roe
NYSE:AMRX Return on Equity February 5th 2021

Unfortunately, that's sub-optimal. However, a low ROE is not always bad. If the company's debt levels are moderate to low, then there's still a chance that returns can be improved via the use of financial leverage. A company with high debt levels and low ROE is a combination we like to avoid given the risk involved. To know the 2 risks we have identified for Amneal Pharmaceuticals visit our risks dashboard for free.

How Does Debt Impact ROE?

Most companies need money -- from somewhere -- to grow their profits. The cash for investment can come from prior year profits (retained earnings), issuing new shares, or borrowing. In the case of the first and second options, the ROE will reflect this use of cash, for growth. In the latter case, the debt required for growth will boost returns, but will not impact the shareholders' equity. In this manner the use of debt will boost ROE, even though the core economics of the business stay the same.

Combining Amneal Pharmaceuticals' Debt And Its 3.0% Return On Equity

We think Amneal Pharmaceuticals uses a significant amount of debt to maximize its returns, as it has a significantly higher debt to equity ratio of 8.00. We consider it to be a negative sign when a company has a rather low ROE despite a rather high debt to equity.

Conclusion

Return on equity is useful for comparing the quality of different businesses. A company that can achieve a high return on equity without debt could be considered a high quality business. If two companies have around the same level of debt to equity, and one has a higher ROE, I'd generally prefer the one with higher ROE.

Having said that, while ROE is a useful indicator of business quality, you'll have to look at a whole range of factors to determine the right price to buy a stock. Profit growth rates, versus the expectations reflected in the price of the stock, are a particularly important to consider. So I think it may be worth checking this free report on analyst forecasts for the company.

Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of interesting companies.

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