This article is intended for those of you who are at the beginning of your investing journey and want to better understand how you can grow your money by investing in LillestrømBanken (OB:LSTSB-ME).
With an ROE of 8.62%, LillestrømBanken (OB:LSTSB-ME) returned in-line to its own industry which delivered 9.57% over the past year. But what is more interesting is whether LSTSB-ME can sustain or improve on this level of return. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of LSTSB-ME’s returns. Let me show you what I mean by this. See our latest analysis for LillestrømBanken
Breaking down Return on Equity
Return on Equity (ROE) is a measure of LillestrømBanken’s profit relative to its shareholders’ equity. An ROE of 8.62% implies NOK0.086 returned on every NOK1 invested, so the higher the return, the better. If investors diversify their portfolio by industry, they may want to maximise their return in the Regional Banks sector by investing in the highest returning stock. However, this can be deceiving as each company has varying costs of equity and debt levels, which could exaggeratedly push up ROE at the same time as accumulating high interest expense.
Return on Equity = Net Profit ÷ Shareholders Equity
Returns are usually compared to costs to measure the efficiency of capital. LillestrømBanken’s cost of equity is 8.40%. LillestrømBanken’s ROE exceeds its cost by 0.22%, which is a big tick. Some of its peers with higher ROE may face a cost which exceeds returns, which is unsustainable and far less desirable than LillestrømBanken’s case of positive discrepancy. ROE can be split up into three useful 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 LillestrømBanken’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. ROE can be inflated by disproportionately high levels of debt. This is also unsustainable due to the high interest cost that the company will also incur. Thus, we should look at LillestrømBanken’s debt-to-equity ratio to examine sustainability of its returns. The ratio currently stands is significantly high, above 2.5 times, meaning LillestrømBanken has taken on a disproportionately large level of debt which is driving its return. The company’s ability to produce profit growth hinges on its 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. Even though LillestrømBanken returned below the industry average, its ROE comes in excess of its cost of equity. However, its concerning leverage level means its ROE is already supported by high debt, raising questions over whether ROE will further decline in the future. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For LillestrømBanken, there are three relevant aspects you should further research:
- Financial Health: Does it have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Future Earnings: How does LillestrømBanken’s growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of LillestrømBanken? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!