Plumas Bancorp (NASDAQ:PLBC) outperformed the Regional Banks industry on the basis of its ROE – producing a higher 17.64% relative to the peer average of 8.93% over the past 12 months. On the surface, this looks fantastic since we know that PLBC has made large profits from little equity capital; however, ROE doesn’t tell us if management have borrowed heavily to make this happen. Today, we’ll take a closer look at some factors like financial leverage to see how sustainable PLBC’s ROE is. Check out our latest analysis for Plumas Bancorp
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. An ROE of 17.64% implies $0.18 returned on every $1 invested. 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
ROE is measured against cost of equity in order to determine the efficiency of Plumas Bancorp’s equity capital deployed. Its cost of equity is 9.77%. Given a positive discrepancy of 7.87% between return and cost, this indicates that Plumas Bancorp pays less for its capital than what it generates in return, which is a sign of capital efficiency. 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
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 Plumas Bancorp’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. Since ROE can be artificially increased through excessive borrowing, we should check Plumas Bancorp’s historic debt-to-equity ratio. Currently the debt-to-equity ratio stands at a low 34.25%, which means its above-average ROE is driven by its ability to grow its profit without a significant debt burden.
What this means for you:
Are you a shareholder? PLBC’s ROE is impressive relative to the industry average and also covers its cost of equity. Since ROE is not inflated by excessive debt, it might be a good time to add more of PLBC to your portfolio if your personal research is confirming what the ROE is telling you. If you’re looking for new ideas for high-returning stocks, you should take a look at our free platform to see the list of stocks with Return on Equity over 20%.