With An ROE Of 8.14%, Has Bendigo and Adelaide Bank Limited’s (ASX:BEN) Management Done Well?

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Shawn Clark

Updated Mon, May 21, 2018, 7:27 PM

Bendigo and Adelaide Bank Limited (ASX:BEN) delivered a less impressive 8.14% ROE over the past year, compared to the 11.83% return generated by its industry. BEN’s results could indicate a relatively inefficient operation to its peers, and while this may be the case, it is important to understand what ROE is made up of and how it should be interpreted. Knowing these components could change your view on BEN’s performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of BEN’s returns. Let me show you what I mean by this. View our latest analysis for Bendigo and Adelaide Bank

Breaking down ROE — the mother of all ratios

Return on Equity (ROE) is a measure of Bendigo and Adelaide Bank’s profit relative to its shareholders’ equity. An ROE of 8.14% implies A$0.08 returned on every A$1 invested. 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 assessed against cost of equity, which is measured using the Capital Asset Pricing Model (CAPM) – but let’s not dive into the details of that today. For now, let’s just look at the cost of equity number for Bendigo and Adelaide Bank, which is 8.55%. Given a discrepancy of -0.41% between return and cost, this indicated that Bendigo and Adelaide Bank 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. The other component, asset turnover, illustrates how much revenue Bendigo and Adelaide Bank 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. Since financial leverage can artificially inflate ROE, we need to look at how much debt Bendigo and Adelaide Bank currently has. Currently the debt-to-equity ratio stands at a balanced 116.90%, which means its ROE is driven by its ability to grow its profit without a significant debt burden.