What’s Really Driving WellCare Health Plans, Inc’s (NYSE: WCG) ROE Of 17%?

in SHAREHOLDER RETURNS by

WellCare Health Plans, Inc’s (NYSE: WCG) most recent return on equity was an outstanding 16.9% in comparison to the Healthcare sector which returned -35.1%. Though WellCare Health’s performance over the past twelve months is highly impressive, it’s useful to understand how the company achieved its strong ROE. Was it a result of profit margins, operating efficiency or maybe even leverage? Knowing these components may change your views on WellCare Health and its future prospects.


ROE Trends Of WellCare Health

Return on equity (ROE) is the amount of net income returned as a percentage of shareholders equity. It is calculated as follows:

ROE = Net Income To Common / Average Total Common Equity

ROE is a helpful metric that illustrates how effective the company is at turning the cash put into the business into gains or returns for investors. But it is important to note that ROE can be impacted by management’s financing decisions such as the deployment of leverage.

The return on equity of WellCare Health is shown below.

WellCare Health's ROE Trends Chart

source: finbox.io data explorer – ROE

It appears that the return on equity of WellCare Health has generally been increasing over the last few years. ROE increased from 7.1% to 13.0% in fiscal year 2016, increased to 16.9% in 2017 and the LTM period is also its latest fiscal year. So what’s causing the general improvement?


WellCare Health’s Improving ROE Trends

In addition to the formula previously discussed, there’s actually another way to calculate ROE. It’s often called the DuPont formula and is as follows:

Return on Equity = Net Profit Margin * Asset Turnover * Equity Multiplier

Analyzing changes in these three items over time allows investors to figure out if operating efficiency, asset use efficiency or the use of leverage is what’s causing changes in ROE. Strong companies should have ROE that is increasing because its net profit margin and/or asset turnover is increasing. On the other hand, a company may not be as strong as investors would otherwise think if ROE is increasing from the use of leverage or debt.

So let’s take a closer look at the drivers behind WellCare Health’s returns.

Net Profit Margin

A promising sign for shareholders, WellCare Health’s net profit margin has increased each year since 2015. Margins increased from 0.9% to 1.7% in fiscal year 2016, increased to 2.2% in 2017 and the LTM period is also its latest fiscal year.

WCG Net Profit Margin Trends

source: data explorer – net profit margin

As a result, the company’s improving margins help explain, at least partially, why ROE is also improving. Now let’s take a look at WellCare Health’s efficiency performance.

Asset Turnover

Unfortunately for shareholders, WellCare Health’s asset turnover has decreased each year since 2015. Turnover decreased from 2.88x to 2.52x in fiscal year 2016, decreased to 2.34x in 2017 and the LTM period is also its latest fiscal year.

WCG Asset Turnover Trends

source: data explorer – asset turnover

Therefore, the company’s improving ROE is not as a result of its asset turnover performance which has been steadily declining.

Finally, the DuPont constituents that make up WellCare Health’s ROE are shown in the table below. Note that the table also compares WellCare Health to a peer group that includes Molina Healthcare Inc (NYSE: MOH), UnitedHealth Group Incorporated (NYSE: UNH), Centene Corporation (NYSE: CNC) and Humana Inc. (NYSE: HUM).

WCG ROE Breakdown vs Peers Table - DuPont Analysis

source: finbox.io’s DuPont model

In conclusion, the DuPont analysis has helped us better understand that WellCare Health’s general improvement in return on equity is the result of steadily improving net profit margin, a declining asset turnover ratio and increasing leverage. Therefore when looking at the core operations of the business, WellCare Health shareholders may need to start worrying due to the company’s steady improvement profitability along with deteriorating operational efficiency and increasing leverage.

The DuPont approach is a helpful tool when analyzing how well management is utilizing shareholder capital. However, it doesn’t necessarily tell the whole story. If you have not done so already, I highly recommend that you complete your research on WellCare Health by taking a look at the following:

Valuation Metrics: how much upside do shares of WellCare Healthl have based on Wall Street’s consensus price target? Take a look at our analyst upside data explorer that compares the company’s upside relative to its peers.

Risk Metrics: how is WellCare Healthl’s financial health? Find out by viewing our financial leverage data metric which plots the dollars in total assets for each dollar of common equity over time.

Efficiency Metrics: is management becoming more or less efficient over time? Find out by analyzing the company’s asset turnover ratio which measures the dollars in revenue a company generates per dollar of assets.

As of this writing, I did not hold a position in any of the aforementioned securities and this is not a buy or sell recommendation on any security mentioned.

Expertise: Valuation, financial statement analysis. Matt Hogan is also a co-founder of finbox.io. His expertise is in investment decision making. Prior to finbox.io, Matt worked for an investment banking group providing fairness opinions in connection to stock acquisitions. He spent much of his time building valuation models to help clients determine an asset’s fair value. He believes that these same valuation models should be used by all investors before buying or selling a stock. His work is frequently published at InvestorPlace, Benzinga, ValueWalk, AAII, Barron’s, Seeking Alpha and investing.com. Matt can be reached at matt@finbox.io or at +1 (516) 778-6257.

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