MidWestOne Financial Group Inc’s (NASDAQ:MOFG) most recent return on equity was a substandard 7.36% relative to its industry performance of 8.88% over the past year. 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 MOFG’s past performance. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of MOFG’s returns. View our latest analysis for MidWestOne Financial Group
What you must know about ROE
Return on Equity (ROE) is a measure of MidWestOne Financial Group’s profit relative to its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.07 in earnings from this. 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 measured against cost of equity in order to determine the efficiency of MidWestOne Financial Group’s equity capital deployed. Its cost of equity is 9.75%. Since MidWestOne Financial Group’s return does not cover its cost, with a difference of -2.39%, this means its current use of equity is not efficient and not sustainable. Very simply, MidWestOne Financial Group 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
Essentially, profit margin shows how much money the company makes after paying for all its expenses. Asset turnover shows how much revenue MidWestOne Financial Group 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 the company’s capital structure is. Since ROE can be artificially increased through excessive borrowing, we should check MidWestOne Financial Group’s historic debt-to-equity ratio. The debt-to-equity ratio currently stands at a sensible 82.87%, meaning the ROE is a result of 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. MidWestOne Financial Group exhibits a weak ROE against its peers, as well as insufficient levels to cover its own cost of equity this year. However, ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of returns, which has headroom to increase further. Although ROE can be a useful metric, it is only a small part of diligent research.
For MidWestOne Financial Group, I’ve compiled 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 MidWestOne Financial Group 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 MidWestOne Financial Group is currently mispriced by the market.
- 3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of MidWestOne Financial Group? 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.