With an ROE of 9.31%, Auburn National Bancorporation Inc (NASDAQ:AUBN) outpaced its own industry which delivered a less exciting 8.92% over the past year. Superficially, this looks great since we know that AUBN has generated big profits with little equity capital; however, ROE doesn’t tell us how much AUBN has borrowed in debt. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of AUBN’s ROE. View our latest analysis for Auburn National Bancorporation
What you must know about ROE
Return on Equity (ROE) weighs AUBN’s profit against the level of its shareholders’ equity. For example, if AUBN invests $1 in the form of equity, it will generate $0.09 in earnings from this. In most cases, a higher ROE is preferred; however, there are many other factors we must consider prior to making any investment decisions.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is assessed against cost of equity, which is measured using the Capital Asset Pricing Model (CAPM) – but let’s not dive into the details of that today. For now, let’s just look at the cost of equity number for AUBN, which is 11.27%. This means AUBN’s returns actually do not cover its own cost of equity, with a discrepancy of -1.95%. This isn’t sustainable as it implies, very simply, that the company pays more for its capital than what it generates in return. ROE can be split up into three useful ratios: net profit margin, asset turnover, and financial leverage. This is called the Dupont Formula:
ROE = profit margin × asset turnover × financial leverage
ROE = (annual net profit ÷ sales) × (sales ÷ assets) × (assets ÷ shareholders’ equity)
ROE = annual net profit ÷ shareholders’ equity
Basically, profit margin measures how much of revenue trickles down into earnings which illustrates how efficient AUBN is with its cost management. Asset turnover shows how much revenue AUBN 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 AUBN’s capital structure is. Since financial leverage can artificially inflate ROE, we need to look at how much debt AUBN currently has. The debt-to-equity ratio currently stands at a low 8.02%, meaning the above-average ROE is due to its capacity to produce profit growth without a huge debt burden.
What this means for you:
Are you a shareholder? AUBN’s above-industry ROE is noteworthy, but it was not high enough to cover its own cost of equity. However, investors shouldn’t despair since ROE is not inflated by excessive debt, which means AUBN still has room to improve shareholder returns by raising debt to fund new investments. If you’re looking for new ideas for high-returning stocks, you should take a look at our free platform to see the list of stocks with Return on Equity over 20%.
Are you a potential investor? If AUBN has been on your watch list for a while, making an investment decision based on ROE alone is unwise. I recommend you do additional fundamental analysis by looking through our most recent infographic report on Auburn National Bancorporation to help you make a more informed investment decision.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.