What is Behind BankUnited Inc’s (NYSE:BKU) Superior ROE?
BankUnited Inc (NYSE:BKU) delivered an ROE of 10.40% over the past 12 months, which is an impressive feat relative to its industry average of 8.91% during the same period. While the impressive ratio tells us that BKU has made significant profits from little equity capital, ROE doesn’t tell us if BKU has borrowed debt to make this happen. Today, we’ll take a closer look at some factors like financial leverage to see how sustainable BKU’s ROE is. View our latest analysis for BankUnited
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) is a measure of BankUnited’s profit relative to its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.1 in earnings from this. Generally speaking, a higher ROE is preferred; however, there are other factors we must also consider before making any conclusions.
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 BankUnited, which is 9.75%. Since BankUnited’s return covers its cost in excess of 0.0064%, its use of equity capital is efficient and likely to be sustainable. Simply put, BankUnited pays less for its capital than what it generates in return. ROE can be broken down into three different ratios: net profit margin, asset turnover, and financial leverage. This is called the Dupont Formula:
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 the business is with its cost management. Asset turnover shows how much revenue BankUnited can generate with its current asset base. Finally, financial leverage will be our main focus today. It shows how much of assets are funded by equity and can show how sustainable the company’s capital structure is. Since ROE can be artificially increased through excessive borrowing, we should check BankUnited’s historic debt-to-equity ratio. The debt-to-equity ratio currently stands at a high 202.06%, meaning the above-average ratio is a result of a large amount of debt.
Next Steps:
While ROE is a relatively simple calculation, it can be broken down into different ratios, each telling a different story about the strengths and weaknesses of a company. BankUnited exhibits a strong ROE against its peers, as well as sufficient returns to cover its cost of equity. Its high debt level means its strong ROE may be driven by debt funding which raises concerns over the sustainability of BankUnited’s returns. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For BankUnited, I’ve compiled three important factors you should look at:
1. Financial Health: Does it have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
2. Valuation: What is BankUnited worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether BankUnited is currently mispriced by the market.
3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of BankUnited? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!
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.
