The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and looking to gauge the potential return on investment in Hawthorn Bancshares Inc (NASDAQ:HWBK).
Hawthorn Bancshares Inc (NASDAQ:HWBK) delivered a less impressive 3.73% ROE over the past year, compared to the 8.45% return generated by its industry. HWBK’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 HWBK’s performance. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of HWBK’s returns. View out our latest analysis for Hawthorn Bancshares
Breaking down Return on Equity
Return on Equity (ROE) weighs Hawthorn Bancshares’s profit against the level of its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.037 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 Hawthorn Bancshares’s equity capital deployed. Its cost of equity is 9.97%. This means Hawthorn Bancshares’s returns actually do not cover its own cost of equity, with a discrepancy of -6.24%. 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 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 reveals how much revenue can be generated from Hawthorn Bancshares’s asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since ROE can be inflated by excessive debt, we need to examine Hawthorn Bancshares’s debt-to-equity level. The debt-to-equity ratio currently stands at a high 184.73%, meaning the below-average ratio is already being driven by a large amount of debt.
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Hawthorn Bancshares’s ROE is underwhelming relative to the industry average, and its returns were also not strong enough to cover its own cost of equity. Its concerning leverage level means its ROE is already supported by high debt, raising questions over whether ROE will further decline in the future. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Hawthorn Bancshares, there are three relevant aspects you should further examine:
- 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.
- Management:Have insiders been ramping up their shares to take advantage of the market’s sentiment for Hawthorn Bancshares’s future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Hawthorn Bancshares? 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.