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NewStar Financial Inc (NEWS): Can It Deliver A Superior ROE To The Industry?

NewStar Financial Inc (NASDAQ:NEWS) generated a below-average return on equity of 3.76% in the past 12 months, while its industry returned 7.78%. Though NEWS's recent performance is underwhelming, it is useful to understand what ROE is made up of and how it should be interpreted. Knowing these components can change your views on NEWS's below-average returns. Today I will look at how components such as financial leverage can influence ROE which may impact the sustainability of NEWS's returns. See our latest analysis for NEWS

Breaking down Return on Equity

Return on Equity (ROE) weighs NEWS’s profit against the level of its shareholders’ equity. It essentially shows how much NEWS can generate in earnings given the amount of equity it has raised. While a higher ROE is preferred in most cases, there are several other factors we should consider before drawing any conclusions.

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 NEWS, which is 9.21%. Since NEWS’s return does not cover its cost, with a difference of -5.44%, this means its current use of equity is not efficient and not sustainable. Very simply, NEWS 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

NasdaqGS:NEWS Last Perf Oct 3rd 17
NasdaqGS:NEWS Last Perf Oct 3rd 17

Basically, profit margin measures how much of revenue trickles down into earnings which illustrates how efficient NEWS is with its cost management. Asset turnover shows how much revenue NEWS 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 NEWS’s capital structure is. Since ROE can be artificially increased through excessive borrowing, we should check NEWS’s historic debt-to-equity ratio. At over 2.5 times, NEWS’s debt-to-equity ratio is very high and indicates the below-average ROE is already being generated by significant leverage levels.

NasdaqGS:NEWS Historical Debt Oct 3rd 17
NasdaqGS:NEWS Historical Debt Oct 3rd 17

What this means for you:

Are you a shareholder? NEWS’s below-industry ROE is disappointing, furthermore, its returns were not even high enough to cover its own cost of equity. Additionally, its high debt level appears to be a key driver of its ROE and is something you should be mindful of before adding more of NEWS to your portfolio.

Are you a potential investor? If NEWS has been on your watch list for a while, making an investment decision based on ROE alone is unwise. I recommend you do additional fundamental analysis by looking through our most recent infographic report on NewStar Financial to help you make a more informed investment decision. If you are not interested in NEWS anymore, you can use our free platform to see our list of stocks with Return on Equity over 20%.


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.

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