Banco Santander (Brasil) SA’s (NYSE:BSBR) 8.9% ROE over the past year fell short of the performance averaged by the industry, which delivered 9.65% ROE in the same period. On the surface, while Banco Santander (Brasil) S.A appears to have underperformed, there’s more to any company’s ROE than just the final figure. That’s why it’s important to dig a little deeper whenever coming accross a ratio as significant as ROE when making investment considerations. See our latest analysis for BSBR
Peeling the layers of ROE – trisecting a company’s profitability
ROE is one of the most popular ratios to calculate the profitability of a company. The ratio is arrived by putting net earnings in the numerator and shareholders’ equity in the denominator.Any ROE north of 20%, implying 20 cents return on every dollar invested, is favourable for any investor. But investors seek multiple assets to diversify risk and an industry-specific comparison makes more sense to achieve the goal of choosing the best among a given lot.
Return on Equity = Net Profit ÷ Shareholders Equity
No matter how high or low return a company generates on equity, it should be more than the cost of equity for value creation. For BSBR, the cost of equity estimate comes at 10.54% based on the Capital Asset Pricing Model using the current risk free rate and a levered beta to account for financial leverage. That compares to Banco Santander (Brasil) S.A’s 8.9% ROE. ROE can be broken down into three ratios using the Dupont formula. The profit margin is the income as a percentage of sales, while asset turnover highlights how efficiently a company is using the resources at its disposal. Increased leverage, primarily through raising debt, is good for a profitable company, but only to the extent it doesn’t make the firm insolvent in a time of crisis.
ROE = annual net profit ÷ shareholders’ equity
ROE = (annual net profit ÷ sales) × (sales ÷ assets) × (assets ÷ shareholders’ equity)
ROE = profit margin × asset turnover × financial leverage
Among the ratios affecting ROE, the profit margin is the most important as it highlights the operational efficiency of a company. To a potential investor, the ideal scenario would be profit increasing at a higher rate than the revenue.While the change in a company’s asset turnover ratio is important in assessing the quality of ROE, an equally important aspect is its comparison to the industry average. Banco Santander (Brasil) S.A generated an ROA of 1.3% versus the industry’s 1.03%. For an industry, ROA, which is earnings as a percentage of assets, is a sound representation of asset turnover.
The last but not the least is the financial leverage. It’s an important ratio as a company can hide its poor operating and asset-use efficiency by increasing leverage. Thus, along with ROE, we should look at the Return on capital, which reflects earnings as a percentage of overall capital employed, including debt. For BSBR, ROC stood at 6% versus the industry’s 0.18%.
Why is ROE called the mother of all ratios
ROE is called the mother of all ratios for a reason. It helps gauge a company’s efficiency both through the income statement and the balance sheet, along with telling you how just changing the capital structure of the company can impact perceived return. What are the analysts thinking about Banco Santander (Brasil) S.A’s ROE in three years? I recommend you see our latest FREE analysis report to find out!
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