Union Bankshares Corporation (NASDAQ:UBSH) generated a below-average return on equity of 7.69% in the past 12 months, while its industry returned 8.93%. Though UBSH’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 UBSH’s below-average returns. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of UBSH’s returns. Let me show you what I mean by this. Check out our latest analysis for Union Bankshares
Breaking down Return on Equity
Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. An ROE of 7.69% implies $0.08 returned on every $1 invested. Generally speaking, a higher ROE is preferred; however, there are other factors we must also consider before making 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 Union Bankshares, which is 9.86%. Since Union Bankshares’s return does not cover its cost, with a difference of -2.17%, this means its current use of equity is not efficient and not sustainable. Very simply, Union Bankshares pays more for its capital than what it generates in return. ROE can be split up into three useful 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
Basically, profit margin measures how much of revenue trickles down into earnings which illustrates how efficient the business is with its cost management. Asset turnover shows how much revenue Union Bankshares 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 inflated by excessive debt, we need to examine Union Bankshares’s debt-to-equity level. Currently the debt-to-equity ratio stands at a balanced 101.32%, which means its ROE is driven by its ability to grow its profit without a significant debt burden.
What this means for you:
Are you a shareholder? UBSH’s below-industry ROE is disappointing, furthermore, its returns were not even high enough to cover its own cost of equity. However, investors shouldn’t despair since ROE is not inflated by excessive debt, which means UBSH still has room to improve shareholder returns by raising debt to fund new investments. 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 UBSH, 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 Union Bankshares 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.