This article is intended for those of you who are at the beginning of your investing journey and want to begin learning the link between Century Bancorp Inc (NASDAQ:CNBK.A)’s return fundamentals and stock market performance.
Century Bancorp Inc (NASDAQ:CNBK.A) delivered an ROE of 8.92% over the past 12 months, which is an impressive feat relative to its industry average of 8.45% during the same period. Superficially, this looks great since we know that CNBK.A has generated big profits with little equity capital; however, ROE doesn’t tell us how much CNBK.A has borrowed in debt. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of CNBK.A’s ROE. Check out our latest analysis for Century Bancorp
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) weighs Century Bancorp’s profit against the level of its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.089 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 Century Bancorp, which is 9.96%. This means Century Bancorp’s returns actually do not cover its own cost of equity, with a discrepancy of -1.05%. 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 broken down into three different 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
Essentially, profit margin shows how much money the company makes after paying for all its expenses. Asset turnover reveals how much revenue can be generated from Century Bancorp’s 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 Century Bancorp’s historic debt-to-equity ratio. At 184.45%, Century Bancorp’s debt-to-equity ratio appears relatively high and indicates the above-average ROE is generated by significant leverage levels.
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Century Bancorp’s above-industry ROE is noteworthy, but it was not high enough to cover its own cost of equity. Its debt level is above equity which means its above-industry ROE may be driven by debt funding which raises concerns over the sustainability of Century Bancorp’s returns. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Century Bancorp, I’ve put together three pertinent factors you should further examine:
- 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.
- Management:Have insiders been ramping up their shares to take advantage of the market’s sentiment for Century Bancorp’s future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Century Bancorp? 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.