ING Groep NV. (ENXTAM:INGA) outperformed the Diversified Banks industry on the basis of its ROE – producing a higher 9.75% relative to the peer average of 8.50% over the past 12 months. On the surface, this looks fantastic since we know that INGA has made large profits from little equity capital; however, ROE doesn’t tell us if management have borrowed heavily to make this happen. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of INGA’s ROE. View our latest analysis for ING Groep
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) is a measure of ING Groep’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. 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 ING Groep’s equity capital deployed. Its cost of equity is 13.63%. Since ING Groep’s return does not cover its cost, with a difference of -3.87%, this means its current use of equity is not efficient and not sustainable. Very simply, ING Groep pays more for its capital than what it generates in return. ROE can be split up into three useful 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. The other component, asset turnover, illustrates how much revenue ING Groep can make from its asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable the company’s capital structure is. Since ROE can be inflated by excessive debt, we need to examine ING Groep’s debt-to-equity level. At over 2.5 times, ING Groep’s debt-to-equity ratio is very high and indicates the above-average ROE is generated by significant leverage levels.
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. ING Groep exhibits a strong ROE against its peers, however it was not high enough to cover its own cost of equity this year. With debt capital in excess of equity, ROE may be inflated by the use of debt funding, raising questions over the sustainability of the company’s returns. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For ING Groep, there are three pertinent factors you should look at:
- 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.
- Valuation: What is ING Groep 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 ING Groep is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of ING Groep? 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.