Will First Bank (FRBA) Continue To Underperform Its Industry?
First Bank’s (NASDAQ:FRBA) most recent return on equity was a substandard 6.96% relative to its industry performance of 8.95% over the past year. An investor may attribute an inferior ROE to a relatively inefficient performance, and whilst this can often be the case, knowing the nuts and bolts of the ROE calculation may change that perspective and give you a deeper insight into FRBA's past performance. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of FRBA's returns. View our latest analysis for First Bank
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) is a measure of FRBA’s profit relative to its shareholders’ equity. An ROE of 6.96% implies $0.07 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. FRBA’s cost of equity is 11.03%. Since FRBA’s return does not cover its cost, with a difference of -4.07%, this means its current use of equity is not efficient and not sustainable. Very simply, FRBA 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:
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 FRBA is with its cost management. Asset turnover shows how much revenue FRBA 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 FRBA’s capital structure is. Since ROE can be artificially increased through excessive borrowing, we should check FRBA’s historic debt-to-equity ratio. The debt-to-equity ratio currently stands at a sensible 60.17%, meaning the ROE is a result of its capacity to produce profit growth without a huge debt burden.
What this means for you:
Are you a shareholder? FRBA’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 FRBA still has room to improve shareholder returns by raising debt to fund new investments. If you're looking for new ideas for high-returning stocks, you should take a look at our free platform to see the list of stocks with Return on Equity over 20%.
Are you a potential investor? If you are considering investing in FRBA, looking at ROE on its own is not enough to make a well-informed decision. I recommend you do additional fundamental analysis by looking through our most recent infographic report on First Bank to help you make a more informed investment decision.
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.
