Lakeland Bancorp Inc (NASDAQ:LBAI) delivered an ROE of 9.28% over the past 12 months, which is an impressive feat relative to its industry average of 8.79% during the same period. Superficially, this looks great since we know that LBAI has generated big profits with little equity capital; however, ROE doesn’t tell us how much LBAI has borrowed in debt. Today, we’ll take a closer look at some factors like financial leverage to see how sustainable LBAI’s ROE is. See our latest analysis for Lakeland Bancorp
Breaking down Return on Equity
Return on Equity (ROE) is a measure of Lakeland Bancorp’s profit relative to its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.09 in earnings from this. 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. Lakeland Bancorp’s cost of equity is 9.73%. Given a discrepancy of -0.0045% between return and cost, this indicated that Lakeland Bancorp may be paying more for its capital than what it’s generating 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
Basically, profit margin measures how much of revenue trickles down into earnings which illustrates how efficient the business is with its cost management. Asset turnover reveals how much revenue can be generated from Lakeland Bancorp’s asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since ROE can be inflated by excessive debt, we need to examine Lakeland Bancorp’s debt-to-equity level. The debt-to-equity ratio currently stands at a sensible 72.34%, meaning the above-average ROE is due to its capacity to produce profit growth without a huge debt burden.
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Lakeland Bancorp’s above-industry ROE is noteworthy, but it was not high enough to cover its own cost of equity. Its high ROE is not likely to be driven by high debt. Therefore, investors may have more confidence in the sustainability of this level of returns going forward. Although ROE can be a useful metric, it is only a small part of diligent research.
For Lakeland Bancorp, I’ve put together three pertinent factors you should look at:
- 1. 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.
- 2. Valuation: What is Lakeland 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 Lakeland Bancorp is currently mispriced by the market.
- 3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Lakeland 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.