SpareBank 1 Nord-Norge (OB:NONG) delivered an ROE of 11.71% over the past 12 months, which is relatively in-line with its industry average of 9.57% during the same period. But what is more interesting is whether NONG can sustain this level of return. A measure of sustainable returns is NONG’s financial leverage. If NONG borrows debt to invest in its business, its profits will be higher. But ROE does not capture any debt, so we only see high profits and low equity, which is great on the surface. But today let’s take a deeper dive below this surface. Check out our latest analysis for SpareBank 1 Nord-Norge
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) is a measure of SpareBank 1 Nord-Norge’s profit relative to its shareholders’ equity. For example, if the company invests NOK1 in the form of equity, it will generate NOK0.12 in earnings from this. 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 misleading as each firm has different costs of equity and debt levels i.e. the more debt SpareBank 1 Nord-Norge has, the higher ROE is pumped up in the short term, at the expense of long term interest payment burden.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is measured against cost of equity in order to determine the efficiency of SpareBank 1 Nord-Norge’s equity capital deployed. Its cost of equity is 8.40%. This means SpareBank 1 Nord-Norge returns enough to cover its own cost of equity, with a buffer of 3.31%. 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:
ROE = profit margin × asset turnover × financial leverage
ROE = (annual net profit ÷ sales) × (sales ÷ assets) × (assets ÷ shareholders’ equity)
ROE = annual net profit ÷ shareholders’ equity
The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. The other component, asset turnover, illustrates how much revenue SpareBank 1 Nord-Norge can make from its 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 SpareBank 1 Nord-Norge’s debt-to-equity ratio to examine sustainability of its returns. The most recent ratio is 209.27%, which is relatively high, indicating SpareBank 1 Nord-Norge’s above-average ROE is generated by its high leverage and its ability to grow profit hinges on a sizeable debt burden.
While ROE is a relatively simple calculation, it can be broken down into different ratios, each telling a different story about the strengths and weaknesses of a company. SpareBank 1 Nord-Norge exhibits a strong ROE against its peers, as well as sufficient returns to cover its cost of equity. With debt capital in excess of equity, ROE may be inflated by the use of debt funding, raising questions over the sustainability of the company’s returns. Although ROE can be a useful metric, it is only a small part of diligent research.
For SpareBank 1 Nord-Norge, I’ve put together three pertinent factors you should look at:
- 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.
- Valuation: What is SpareBank 1 Nord-Norge worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether SpareBank 1 Nord-Norge is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of SpareBank 1 Nord-Norge? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!