In This Article:
First Internet Bancorp’s (NASDAQ:INBK) most recent return on equity was a substandard 6.79% relative to its industry performance of 8.17% over the past year. INBK’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 INBK’s performance. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of INBK’s returns. Check out our latest analysis for First Internet Bancorp
What you must know about ROE
Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. 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 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 First Internet Bancorp, which is 9.90%. This means First Internet Bancorp’s returns actually do not cover its own cost of equity, with a discrepancy of -3.11%. 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 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. Asset turnover reveals how much revenue can be generated from First Internet Bancorp’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 ROE can be inflated by excessive debt, we need to examine First Internet Bancorp’s debt-to-equity level. The debt-to-equity ratio currently stands at a high 199.28%, meaning the below-average ratio is already being driven by a large amount of debt.