Public Joint Stock Company BANK URALSIB (MISX:USBN) generated a below-average return on equity of 5.42% in the past 12 months, while its industry returned 9.34%. Though USBN’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 USBN’s below-average returns. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of USBN’s returns. Let me show you what I mean by this. View our latest analysis for BANK URALSIB
What you must know about ROE
Return on Equity (ROE) weighs BANK URALSIB’s profit against the level of its shareholders’ equity. For example, if the company invests RUB1 in the form of equity, it will generate RUB0.05 in earnings from this. 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. BANK URALSIB’s cost of equity is 13.41%. Given a discrepancy of -7.99% between return and cost, this indicated that BANK URALSIB may be paying more for its capital than what it’s generating 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
Basically, profit margin measures how much of revenue trickles down into earnings which illustrates how efficient the business is with its cost management. The other component, asset turnover, illustrates how much revenue BANK URALSIB can make from its 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 BANK URALSIB’s debt-to-equity level. Currently the debt-to-equity ratio stands at a high 186.79%, which means its below-average ROE is already being driven by significant debt levels.
Next Steps:
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. BANK URALSIB’s below-industry ROE is disappointing, furthermore, its returns were not even high enough to cover its own cost of equity. 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.