What You Must Know About Orrstown Financial Services Inc's (NASDAQ:ORRF) 6.81% ROE

I am writing today to help inform people who are new to the stock market and want to begin learning the link between Orrstown Financial Services Inc (NASDAQ:ORRF)’s return fundamentals and stock market performance.

Orrstown Financial Services Inc (NASDAQ:ORRF) delivered an ROE of 6.81% over the past 12 months, which is relatively in-line with its industry average of 8.45% during the same period. But what is more interesting is whether ORRF 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 ORRF's returns. Let me show you what I mean by this. View out our latest analysis for Orrstown Financial Services

What you must know about ROE

Return on Equity (ROE) weighs Orrstown Financial Services’s profit against the level of its shareholders’ equity. An ROE of 6.81% implies $0.068 returned on every $1 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. But this can be misleading as each company has different costs of equity and also varying debt levels, which could artificially push up ROE whilst accumulating high interest expense.

Return on Equity = Net Profit ÷ Shareholders Equity

ROE is measured against cost of equity in order to determine the efficiency of Orrstown Financial Services’s equity capital deployed. Its cost of equity is 8.70%. Given a discrepancy of -1.89% between return and cost, this indicated that Orrstown Financial Services may be paying more for its capital than what it’s generating in return. 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 Orrstown Financial Services’s asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable the company’s capital structure is. We can determine if Orrstown Financial Services’s ROE is inflated by borrowing high levels of debt. Generally, a balanced capital structure means its returns will be sustainable over the long run. We can examine this by looking at Orrstown Financial Services’s debt-to-equity ratio. The most recent ratio is 124.48%, which is relatively proportionate and indicates Orrstown Financial Services has not taken on extreme leverage. Thus, we can conclude its current ROE is generated from its capacity to increase profit without a massive debt burden.

Next Steps:

ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Orrstown Financial Services’s ROE is underwhelming relative to the industry average, and its returns were also not strong enough to cover its own cost of equity. However, ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of returns, which has headroom to increase further. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.

For Orrstown Financial Services, there are three important aspects you should further research:

1. 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.
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for Orrstown Financial Services's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Orrstown Financial Services? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!

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Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.