With an ROE of 10.80%, Southside Bancshares Inc (NASDAQ:SBSI) outpaced its own industry which delivered a less exciting 8.57% over the past year. While the impressive ratio tells us that SBSI has made significant profits from little equity capital, ROE doesn’t tell us if SBSI has borrowed debt to make this happen. We’ll take a closer look today at factors like financial leverage to determine whether SBSI’s ROE is actually sustainable. View our latest analysis for Southside Bancshares
Breaking down Return on Equity
Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.11 in earnings from this. Generally speaking, a higher ROE is preferred; however, there are other factors we must also consider before making any conclusions.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is measured against cost of equity in order to determine the efficiency of Southside Bancshares’s equity capital deployed. Its cost of equity is 9.87%. This means Southside Bancshares returns enough to cover its own cost of equity, with a buffer of 0.0093%. 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 Southside Bancshares can make from its 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. Since ROE can be inflated by excessive debt, we need to examine Southside Bancshares’s debt-to-equity level. Currently the debt-to-equity ratio stands at a high 235.63%, which means its above-average ROE is driven by significant debt levels.
Next Steps:
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Southside Bancshares’s above-industry ROE is encouraging, and is also in excess of 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. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.