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With An ROE Of 7.36%, Has MidWestOne Financial Group Inc’s (NASDAQ:MOFG) Management Done A Good Job?

Shawn Clark

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:

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:MOFG Last Perf Jan 25th 18

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.

NasdaqGS:MOFG Historical Debt Jan 25th 18

Next Steps:

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:

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.