AmeriServ Financial Inc (NASDAQ:ASRV) generated a below-average return on equity of 5.52% in the past 12 months, while its industry returned 8.92%. 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 ASRV’s past performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of ASRV’s returns. Let me show you what I mean by this. Check out our latest analysis for AmeriServ Financial
What you must know about ROE
Return on Equity (ROE) weighs ASRV’s profit against the level of its shareholders’ equity. For example, if ASRV invests $1 in the form of equity, it will generate $0.06 in earnings from this. 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 measured against cost of equity in order to determine the efficiency of ASRV’s equity capital deployed. Its cost of equity is 11.27%. Since ASRV’s return does not cover its cost, with a difference of -5.75%, this means its current use of equity is not efficient and not sustainable. Very simply, ASRV 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
The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. Asset turnover reveals how much revenue can be generated from ASRV’s asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since financial leverage can artificially inflate ROE, we need to look at how much debt ASRV currently has. The debt-to-equity ratio currently stands at a sensible 87.63%, 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? ASRV exhibits a weak ROE against its peers, as well as insufficient levels to cover its own cost of equity this year. Since its existing ROE is not fuelled by unsustainable debt, investors shouldn’t give up as ASRV still has capacity to improve shareholder returns by borrowing to invest in new projects in the future. 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 ASRV, 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 AmeriServ 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.