With an ROE of 9.79%, Landmark Bancorp Inc (NASDAQ:LARK) outpaced its own industry which delivered a less exciting 8.95% over the past year. Superficially, this looks great since we know that LARK has generated big profits with little equity capital; however, ROE doesn’t tell us how much LARK has borrowed in debt. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of LARK’s ROE. See our latest analysis for LARK

What you must know about ROE

Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. For example, if LARK invests $1 in the form of equity, it will generate $0.1 in earnings from this. In most cases, a higher ROE is preferred; however, there are many other factors we must consider prior to making any investment decisions.

Return on Equity = Net Profit ÷ Shareholders Equity

Returns are usually compared to costs to measure the efficiency of capital. LARK’s cost of equity is 11.02%. Since LARK’s return does not cover its cost, with a difference of -1.24%, this means its current use of equity is not efficient and not sustainable. Very simply, LARK pays more for its capital than what it generates in return. ROE can be dissected into three distinct 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 LARK can make from its asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since ROE can be artificially increased through excessive borrowing, we should check LARK’s historic debt-to-equity ratio. The debt-to-equity ratio currently stands at a sensible 70.12%, meaning the above-average ROE is due to its capacity to produce profit growth without a huge debt burden.

What this means for you:

Are you a shareholder? LARK exhibits a strong ROE against its peers, however it was not high enough to cover its own cost of equity this year. However, investors shouldn’t despair since ROE is not inflated by excessive debt, which means LARK still has room to improve shareholder returns by raising debt to fund new investments.

Are you a potential investor? If you are considering investing in LARK, looking at ROE on its own is not enough to make a well-informed decision. I recommend you do additional fundamental analysis by looking through our most recent infographic report on Landmark Bancorp to help you make a more informed investment decision. If you are not interested in LARK anymore, you can use our free platform to see our list of stocks with Return on Equity over 20%.

To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned.