Case 2

The return on total assets indicates the efficiency with which management has used the company’s available resources to generate income. So ROA is a key ratio for a company’s profitability. From the table above, we can see that Orrstown outperformed its peer in terms of ROA, which indicates Orrstown utilized its assets more efficiently during those three years. However, from 2009, Orrstown’s ROA began to decrease year by year, down to a very negative level in 2012 (-3.12%). Citizens did much better over the following years, with its ROA going up at a stable rate.

ROE

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TABLE 4

The return on owners’ equity is also an indicative ratio for a company’s profitability, but it emphasizes more on how much the company can earn for its investors. According to the ROE table, we noticed that Orrstown did much worse than Citizens. So Orrstown’s constantly deteriorating ROE would destroy investors’ confidence and scare them away, which is very dangerous for its long-term development.

We can use DuPont Analysis to break ROE into three parts.

ROE = (Profit margin)*(Asset turnover)*(Equity multiplier).

Each part reflects a company’s Profitability, Operating efficiency, Financial leverage respectively.

See the detailed data below.

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TABLE 5

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TABLE 6

According to the three individual parts derived from ROE, we can see that before 2009 Orrstown was much less leveraged compared with its peer. After 2009, Orrstown relied more on debt to finance. And in terms of Profit Margin, Orrstown exhibited a better performance during 2006-2009. But after that, Orrstown suffered large losses, resulting in negative profit margin.

Operating Leverage

Firms with high proportion of fixed costs experiences significant increases in operating incomes as sales increase. A leverage is to increase fixed cost or to add debt, in order to essentially lower the variable cost, to hopefully increase the operating income.

The degree of Operating Leverage...