United Bankshares Inc’s (NASDAQ:UBSI) most recent return on equity was a substandard 5.96% relative to its industry performance of 8.95% over the past year. UBSI'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 UBSI’s performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of UBSI's returns. Let me show you what I mean by this. See our latest analysis for UBSI
What you must know about ROE
Return on Equity (ROE) weighs UBSI’s profit against the level of its shareholders’ equity. It essentially shows how much UBSI 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
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 UBSI, which is 8.49%. Given a discrepancy of -2.53% between return and cost, this indicated that UBSI may be paying more for its capital than what it’s generating 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
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 UBSI’s asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable UBSI’s capital structure is. Since ROE can be inflated by excessive debt, we need to examine UBSI’s debt-to-equity level. At 52.17%, UBSI’s debt-to-equity ratio appears sensible and indicates its ROE is generated from its capacity to increase profit without a large debt burden.
What this means for you:
Are you a shareholder? UBSI’s below-industry ROE is disappointing, furthermore, its returns were not even high enough to cover its own cost of equity. Since its existing ROE is not fuelled by unsustainable debt, investors shouldn’t give up as UBSI 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 you are considering investing in UBSI, 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 United 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.