How Did Chemung Financial Corporation’s (CHMG) 7.88% ROE Fare Against The Industry?
Chemung Financial Corporation (NASDAQ:CHMG) generated a below-average return on equity of 7.88% in the past 12 months, while its industry returned 8.95%. CHMG's results could indicate a relatively inefficient operation to its peers, and while this may be the case, it is important to understand what ROE is made up of and how it should be interpreted. Knowing these components could change your view on CHMG’s performance. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of CHMG's returns. See our latest analysis for CHMG
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) is a measure of CHMG’s profit relative to its shareholders’ equity. An ROE of 7.88% implies $0.08 returned on every $1 invested. 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 measured against cost of equity in order to determine the efficiency of CHMG’s equity capital deployed. Its cost of equity is 11.02%. Given a discrepancy of -3.15% between return and cost, this indicated that CHMG may be paying more for its capital than what it’s generating 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
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 CHMG’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 CHMG’s capital structure is. Since ROE can be inflated by excessive debt, we need to examine CHMG’s debt-to-equity level. At 16.84%, CHMG’s debt-to-equity ratio appears low and indicates that CHMG still has room to increase leverage and grow its profits.
What this means for you:
Are you a shareholder? CHMG’s below-industry ROE is disappointing, furthermore, its returns were not even high enough to cover its own cost of equity. However, investors shouldn’t despair since ROE is not inflated by excessive debt, which means CHMG still has room to improve shareholder returns by raising debt to fund new investments.
Are you a potential investor? If you are considering investing in CHMG, basing your decision on ROE alone is certainly not sufficient. I recommend you do additional fundamental analysis by looking through our most recent infographic report on Chemung Financial to help you make a more informed investment decision. If you are not interested in CHMG anymore, you can use our free platform to see our list of stocks with Return on Equity over 20%.
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.
