Why CSL Limited shares could be a strong buy today

Healthcare stocks have been a great way to crush the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO) over the last few years and I am a big fan of the bigger, globally diversified companies which make up the S&P/ASX 200 Health Care Index (Index: ASX: XHJ).

Blood product company CSL Limited (ASX: CSL) is one of the biggest, but is it still a buy today?

The price of success?

Selling for 27x its trailing earnings, CSL looks slightly more expensive than the average of the S&P/ASX 200 Health Care Index at 23, especially given the company’s relatively soft revenue growth of 2% in the 2015 financial year.

What this growth figure hides, however, is a massive return on equity (ROE) from a company absolutely hosing out cash.

Return on equity is hugely important because it measures the return the company generates internally for investors. High returns can be invested back into the company to be compounded year after year, or returned to investors via dividends or share buy-backs.

CSL’s return on equity (ROE) for the 2015 financial year was an incredible 50%. This was up 9% from 2014 as the result of a massive AU$950 million on-market share buy-back that reduced the equity in the business, while net profit grew.

CSL Limited 2015 2014 2013 2012 2010
Net Income (US$) 1,379 1,307 1,211 1,024 918
Total equity (US$) 2,746 3,162 3,018 3,477 3,917
ROE 50% 41% 40% 29% 23%

Of course, most companies are financed by a mix of debt and shareholder equity, so it’s important to check high return is not a result of the company loading up on debt, which is a potential risk for shareholders. At 30 June 2015 CSL had a debt-to-equity ratio of 1.3x which is similar to Cochlear Limited (ASX: COH) and seems appropriate given the strong cash flow.

The other question we need to ask is if the high ROE is sustainable, to allow compounding over time. CSL holds a huge number of patents over its products, which act as a competitive advantage over competitors, while the company’s recent run of strong returns on equity per the table above also adds confidence.

Is CSL a buy today?

Buoyed by a strong line of products and a growing market, in my view CSL has a lot of potential to continue to compound and deliver high returns to investors. So long as product quality is maintained and debt is managed, I would be very happy to own CSL today.

Prefer dividends to CSL? Get our Top Dividend Stock for 2016- FREE!

Our resident dividend expert names his Top Dividend Share for 2016. Not only are the shares dirt cheap, the company is trading on a 5.6% fully franked dividend yield. Simply click here to gain access to this comprehensive FREE investment report, including the name of this fast growing ASX dividend share. No credit card required!

Motley Fool contributor Regan Pearson has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

Two New Stock Picks Every Month!

Not to alarm you, but you’re about to miss a very important event! Chief Investment Advisor Scott Phillips and his team at Motley Fool Share Advisor are about to reveal their latest official stock recommendation. The premium “buy alert” will be unveiled to members and you can be among the first to act on the tip.

Don’t let this opportunity pass you by – this is your chance to get in early!

Simply enter your email now to find out how you can get instant access.

By clicking this button, you agree to our Terms of Service and Privacy Policy. We will use your email address only to keep you informed about updates to our website and about other products and services we think might interest you. You can unsubscribe from Take Stock at anytime. Please refer to our Financial Services Guide (FSG) for more information.