What You Must Know About OceanFirst Financial Corp’s (undefined:OCFC) ROE
OceanFirst Financial Corp (NASDAQ:OCFC) delivered an ROE of 7.61% over the past 12 months, which is an impressive feat relative to its industry average of 5.78% during the same period. On the surface, this looks fantastic since we know that OCFC has made large profits from little equity capital; however, ROE doesn’t tell us if management have borrowed heavily to make this happen. We’ll take a closer look today at factors like financial leverage to determine whether OCFC’s ROE is actually sustainable. See our latest analysis for OceanFirst Financial
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) weighs OceanFirst Financial’s profit against the level of its shareholders’ equity. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. 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 assessed against cost of equity, which is measured using the Capital Asset Pricing Model (CAPM) – but let’s not dive into the details of that today. For now, let’s just look at the cost of equity number for OceanFirst Financial, which is 9.08%. Since OceanFirst Financial’s return does not cover its cost, with a difference of -1.47%, this means its current use of equity is not efficient and not sustainable. Very simply, OceanFirst Financial 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:
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
The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. The other component, asset turnover, illustrates how much revenue OceanFirst Financial 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 financial leverage can artificially inflate ROE, we need to look at how much debt OceanFirst Financial currently has. Currently the debt-to-equity ratio stands at a reasonable 65.57%, which means its above-average ROE is driven by its ability to grow its profit without a significant debt burden.
What this means for you:
Are you a shareholder? OCFC’s ROE is impressive relative to the industry average, though its returns were not strong enough to cover its own cost of equity. However, investors shouldn’t despair since ROE is not inflated by excessive debt, which means OCFC 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 OCFC, 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 OceanFirst Financial 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.
