question archive CSL is one of the largest biotechnology firms in Australasia, and over an extended period of time it consistently earned higher ROEs than the biotech industry as a whole
CSL is one of the largest biotechnology firms in Australasia, and over an extended period of time it consistently earned higher ROEs than the biotech industry as a whole
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CSL is one of the largest biotechnology firms in Australasia, and over an extended period of time it consistently earned higher ROEs than the biotech industry as a whole. As a biotechnology analyst, what factors would you consider to be important in making projections of future ROEs for CSL? In particular, what factors would lead you to expect CSL to continue to be a superior performer in its industry, and what factors would lead you to expect CSL’s future performance to revert to that of the industry as a whole?
CSL is one of the largest biotechnology firms in Australasia, and over an extended period of time it consistently earned higher ROEs than the biotech industry as a whole. As a biotechnology analyst, what factors would you consider to be important in making projections of future ROEs for CSL? In particular, what factors would lead you to expect CSL to continue to be a superior performer in its industry, and what factors would lead you to expect CSL’s future performance to revert to that of the industry as a whole?
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Answer:
Factors contributing to CSL continuing to be a high ROE performer, CSL can enjoy superior ROEs for long period if it builds high entry barriers such as patents, economies of scales arising from large investment in research and development, and a strong brand name (which can be achieved by advertising or past performance). In addition, major economic assets, such as the intangible value of research and development, are not recorded in the balance sheet. Therefore, it is excluded from the denominator of ROE.
Factors that causing CSL to revert the industry, first is abnormal high profit attracts competition. Increased competition may low CSL’s ROE. Second, firms with high ROE expands their equity bases more quickly than others, which causes the denominator of to ROE to increase. But if firms able to earns the returns on the new investment that match the returns from the old ones, then the level of ROE can be maintained. However, it is not easily achieved. In practice, one would typically not expect a firm to continue to extend its abnormal profitability. It is likely that CSL earnings growth will not keep pace with the equity growth, hence, leading ROE to fall.
