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Which of the Regional Southwest Banks stocks should you have in your portfolio? That’s a pretty ambiguous question, and one that’s difficult to answer. We’re not going to give you picks. However, there is a financial ratio that’s often overlooked that might offer some insight into which companies in the industry are most fundamentally sound.
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| | | {loadposition contentad} | | | | | Investors watch and understand P/E ratio with a keep eye, using it to make trading decisions. And most know and understand market capitalization and other major financial metrics as a part of analyzing the fundamental health of a stock. However, many traders are not well versed in a very useful ratio for screening and comparing stocks in an industry: Return on Equity (ROE). Return on equity at its most basic is a ratio of net income divided by net assets. It is sometimes averaged over time and referred to as Return on Average Equity. Either way, it's a very useful measure because it considers many other ratios as part of its calculation. So simply stated, Return on Equity is Net Income divided by Shareholder Equity or Net Assets. This is useful because the ratio you end up with is an indication of how well the company turns its assets into income. Here's a resource to better understand how ROE is calculated. But here's the other key: it is only useful as you compare it to stocks within similar industries or the same sector. An ROE in one industry may be very good whereas the same score in another sector might be under-performing. Also, ROE is more useful as you look at how it changes over time. Take the Regional Southwest Banks stocks as an example. UMB Financial Corporation (UMBF) has a solid market cap of 1.63B. Its return on equity is 8.76%. But what does that really mean? You should compare it with related stocks to make the measure useful. UMBF competitor Prosperity Bancshares Inc. (PRSP) has a smaller market cap, and has a return on equity of 7.16%. When you compare the two, the higher ROE tells you which stock is better at turning assets into profit. Another competitor, International Bancshares Corp. (IBOC), is in the same industry and has an ROE of 12.00%. Now, using any one indicator alone as your only fundamental analysis isn't a good idea. So make sure the companies you are analyzing don't have any extenuating circumstances that are skewing ROE, like an acquisition or some kind of write-off. But when used properly, return on equity can provide a great tool for seeing which stocks in a particular group most effectively turn assets into profits and therefore stand out above peers.
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