Camden National Corporation (NASDAQ:CAC) outperformed the Regional Banks industry on the basis of its ROE – producing a higher 10.54% relative to the peer average of 8.93% over the past 12 months. Superficially, this looks great since we know that CAC has generated big profits with little equity capital; however, ROE doesn’t tell us how much CAC has borrowed in debt. We’ll take a closer look today at factors like financial leverage to determine whether CAC’s ROE is actually sustainable. Check out our latest analysis for Camden National
What you must know about ROE
Return on Equity (ROE) is a measure of Camden National’s profit relative to its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.11 in earnings from this. While a higher ROE is preferred in most cases, there are several other factors we should consider before drawing 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 Camden National, which is 9.86%. This means Camden National returns enough to cover its own cost of equity, with a buffer of 0.68%. This sustainable practice implies that the company pays less for its capital than what it generates in return. ROE can be dissected into three distinct 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 the business is with its cost management. Asset turnover shows how much revenue Camden National can generate with its current asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since ROE can be artificially increased through excessive borrowing, we should check Camden National’s historic debt-to-equity ratio. The debt-to-equity ratio currently stands at a balanced 149.71%, 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? CAC’s above-industry ROE is encouraging, and is also in excess of its cost of equity. Since ROE is not inflated by excessive debt, it might be a good time to add more of CAC to your portfolio if your personal research is confirming what the ROE is telling you. 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 you are considering investing in CAC, looking at ROE on its own is not enough to make a well-informed decision. I recommend you do additional fundamental analysis by looking through our most recent infographic report on Camden National 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.