ServisFirst Bancshares Inc (NASDAQ:SFBS) outperformed the Regional Banks industry on the basis of its ROE – producing a higher 16.40% relative to the peer average of 8.48% over the past 12 months. Superficially, this looks great since we know that SFBS has generated big profits with little equity capital; however, ROE doesn’t tell us how much SFBS has borrowed in debt. Today, we’ll take a closer look at some factors like financial leverage to see how sustainable SFBS’s ROE is. See our latest analysis for ServisFirst Bancshares

Breaking down Return on Equity

Return on Equity (ROE) weighs ServisFirst Bancshares’s profit against the level of its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.16 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

ROE is measured against cost of equity in order to determine the efficiency of ServisFirst Bancshares’s equity capital deployed. Its cost of equity is 9.90%. Given a positive discrepancy of 6.49% between return and cost, this indicates that ServisFirst Bancshares pays less for its capital than what it generates in return, which is a sign of capital efficiency. 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

The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. The other component, asset turnover, illustrates how much revenue ServisFirst Bancshares can make from its asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since ROE can be inflated by excessive debt, we need to examine ServisFirst Bancshares’s debt-to-equity level. The debt-to-equity ratio currently stands at a sensible 62.16%, meaning the above-average ROE is due to its capacity to produce profit growth without a huge debt burden.

Next Steps:

While ROE is a relatively simple calculation, it can be broken down into different ratios, each telling a different story about the strengths and weaknesses of a company. ServisFirst Bancshares exhibits a strong ROE against its peers, as well as sufficient returns to cover its cost of equity. ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of high returns. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.

For ServisFirst Bancshares, there are three essential aspects you should further examine:

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. Valuation: What is ServisFirst Bancshares worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether ServisFirst Bancshares is currently mispriced by the market.

3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of ServisFirst Bancshares? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!

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.