Malvern Bancorp Inc (NASDAQ:MLVF) outperformed the Thrifts and Mortgage Finance industry on the basis of its ROE – producing a higher 5.08% relative to the peer average of 4.99% over the past 12 months. Superficially, this looks great since we know that MLVF has generated big profits with little equity capital; however, ROE doesn’t tell us how much MLVF has borrowed in debt. We’ll take a closer look today at factors like financial leverage to determine whether MLVF’s ROE is actually sustainable. View our latest analysis for Malvern Bancorp
Breaking down ROE — the mother of all ratios
Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. 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. Malvern Bancorp’s cost of equity is 9.78%. This means Malvern Bancorp’s returns actually do not cover its own cost of equity, with a discrepancy of -4.70%. 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 shows how much revenue Malvern Bancorp can generate with its current 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 Malvern Bancorp’s debt-to-equity level. At 142.78%, Malvern Bancorp’s debt-to-equity ratio appears balanced and indicates the above-average ROE is generated from its capacity to increase profit without a large debt burden.
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Malvern Bancorp’s above-industry ROE is noteworthy, but it was not high enough to cover its own cost of equity. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Malvern Bancorp, I’ve put together 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.
- Valuation: What is Malvern Bancorp 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 Malvern Bancorp is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Malvern 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.