The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to better understand how you can grow your money by investing in Fauquier Bankshares Inc (NASDAQ:FBSS).
Fauquier Bankshares Inc’s (NASDAQ:FBSS) most recent return on equity was a substandard 5.85% relative to its industry performance of 8.45% over the past year. Though FBSS’s recent performance is underwhelming, it is useful to understand what ROE is made up of and how it should be interpreted. Knowing these components can change your views on FBSS’s below-average returns. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of FBSS’s returns. View out our latest analysis for Fauquier Bankshares
Breaking down Return on Equity
Return on Equity (ROE) is a measure of Fauquier Bankshares’s profit relative to its shareholders’ equity. An ROE of 5.85% implies $0.058 returned on every $1 invested. 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
Returns are usually compared to costs to measure the efficiency of capital. Fauquier Bankshares’s cost of equity is 9.96%. Since Fauquier Bankshares’s return does not cover its cost, with a difference of -4.12%, this means its current use of equity is not efficient and not sustainable. Very simply, Fauquier Bankshares pays more 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. The other component, asset turnover, illustrates how much revenue Fauquier Bankshares can make from its 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 Fauquier Bankshares’s historic debt-to-equity ratio. Currently the debt-to-equity ratio stands at a reasonable 74.17%, which means its ROE is driven by its ability to grow its profit without a significant debt burden.
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. Fauquier Bankshares’s ROE is underwhelming relative to the industry average, and its returns were also not strong enough to cover its own cost of equity. However, ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of returns, which has headroom to increase further. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Fauquier Bankshares, there are three key factors you should further research:
- 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 Fauquier Bankshares’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 Fauquier Bankshares? 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.