With An ROE Of 5.96%, Has Oconee Federal Financial Corp’s (NASDAQ:OFED) Management Done A Good Job?
Oconee Federal Financial Corp (NASDAQ:OFED) generated a below-average return on equity of 5.96% in the past 12 months, while its industry returned 6.46%. OFED’s results could indicate a relatively inefficient operation to its peers, and while this may be the case, it is important to understand what ROE is made up of and how it should be interpreted. Knowing these components could change your view on OFED’s performance. Today I will look at how components such as financial leverage can influence ROE which may impact the sustainability of OFED’s returns. Check out our latest analysis for Oconee Federal Financial
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) weighs Oconee Federal Financial’s profit against the level of its shareholders’ equity. An ROE of 5.96% implies $0.06 returned on every $1 invested. 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
Returns are usually compared to costs to measure the efficiency of capital. Oconee Federal Financial’s cost of equity is 9.97%. Given a discrepancy of -4.01% between return and cost, this indicated that Oconee Federal Financial may be paying more for its capital than what it’s generating 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:
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 Oconee Federal 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 ROE can be inflated by excessive debt, we need to examine Oconee Federal Financial’s debt-to-equity level. Currently the debt-to-equity ratio stands at a low 11.59%, which means Oconee Federal Financial still has headroom to take on more leverage in order to increase profits.
Next Steps:
While ROE is a relatively simple calculation, it can be broken down into different ratios, each telling a different story about the strengths and weaknesses of a company. Oconee Federal Financial’s ROE is underwhelming relative to the industry average, and its returns were also not strong enough to cover its own cost of equity. Although, its appropriate level of leverage means investors can be more confident in the sustainability of Oconee Federal Financial’s return with a possible increase should the company decide to increase its debt levels. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Oconee Federal Financial, I’ve put together three relevant aspects you should further research:
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 Oconee Federal Financial 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 Oconee Federal Financial is currently mispriced by the market.
3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Oconee Federal Financial? 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.
