In This Article:
I am writing today to help inform people who are new to the stock market and want to begin learning the link between company’s fundamentals and stock market performance.
Stock Yards Bancorp Inc (NASDAQ:SYBT) delivered an ROE of 12.63% over the past 12 months, which is an impressive feat relative to its industry average of 8.83% during the same period. While the impressive ratio tells us that SYBT has made significant profits from little equity capital, ROE doesn’t tell us if SYBT has borrowed debt to make this happen. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of SYBT’s ROE.
Check out our latest analysis for Stock Yards Bancorp
What you must know about ROE
Return on Equity (ROE) is a measure of Stock Yards Bancorp’s profit relative to its shareholders’ equity. An ROE of 12.63% implies $0.13 returned on every $1 invested. 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 Stock Yards Bancorp’s equity capital deployed. Its cost of equity is 9.81%. This means Stock Yards Bancorp returns enough to cover its own cost of equity, with a buffer of 2.82%. This sustainable practice implies that the company pays less 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
Essentially, profit margin shows how much money the company makes after paying for all its expenses. The other component, asset turnover, illustrates how much revenue Stock Yards Bancorp can make from its asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since ROE can be artificially increased through excessive borrowing, we should check Stock Yards Bancorp’s historic debt-to-equity ratio. At 118.86%, Stock Yards Bancorp’s debt-to-equity ratio appears balanced and indicates the above-average ROE is generated from its capacity to increase profit without a large debt burden.
Next Steps:
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Stock Yards Bancorp exhibits a strong ROE against its peers, as well as sufficient returns to cover its cost of equity. Its high ROE is not likely to be driven by high debt. Therefore, investors may have more confidence in the sustainability of this level of returns going forward. Although ROE can be a useful metric, it is only a small part of diligent research.