Baldwin & Lyons Inc’s (NASDAQ:BWIN.B) most recent return on equity was a substandard 1.65% relative to its industry performance of 9.11% over the past year. Though BWIN.B’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 BWIN.B’s below-average returns. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of BWIN.B’s returns. See our latest analysis for Baldwin & Lyons
What you must know about ROE
Return on Equity (ROE) is a measure of Baldwin & Lyons’s profit relative to its shareholders’ equity. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. 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
Returns are usually compared to costs to measure the efficiency of capital. Baldwin & Lyons’s cost of equity is 8.49%. This means Baldwin & Lyons’s returns actually do not cover its own cost of equity, with a discrepancy of -6.84%. This isn’t sustainable as it implies, very simply, that the company pays more for its capital than what it generates in return. ROE can be dissected into three distinct 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 reveals how much revenue can be generated from Baldwin & Lyons’s asset base. Finally, financial leverage will be our main focus today. It shows how much of assets are funded by equity and can show how sustainable the company’s capital structure is. Since financial leverage can artificially inflate ROE, we need to look at how much debt Baldwin & Lyons currently has. Currently the debt-to-equity ratio stands at a low 4.94%, which means Baldwin & Lyons still has headroom to take on more leverage in order to increase profits.
What this means for you:
Are you a shareholder? BWIN.B’s ROE is underwhelming relative to the industry average, and its returns were also not strong enough to cover its own cost of equity. Since its existing ROE is not fuelled by unsustainable debt, investors shouldn’t give up as BWIN.B 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 BWIN.B has been on your watch list for a while, making an investment decision based on ROE alone is unwise. I recommend you do additional fundamental analysis by looking through our most recent infographic report on Baldwin & Lyons 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.