Is SLM Corporation (NASDAQ: SLM) Management Utilizing Shareholder’s Equity Efficiently?

in SHAREHOLDER RETURNS by

SLM Corporation’s (NASDAQ: SLM) most recent return on equity was an above average 15.0% in comparison to the Financials sector which returned 8.4%. Though SLM Corp’s performance over the past twelve months is impressive, it’s useful to understand how the company achieved its healthy ROE. Was it a result of profit margins, operating efficiency or maybe even leverage? Knowing these components may change your views on SLM Corp and its future prospects.


ROE Trends Of SLM Corp

Return on equity (ROE) is the amount of net income returned as a percentage of shareholders equity. It is calculated as follows:

ROE = Net Income To Common / Average Total Common Equity

ROE is a helpful metric that illustrates how effective the company is at turning the cash put into the business into gains or returns for investors. But it is important to note that ROE can be impacted by management’s financing decisions such as the deployment of leverage.

The return on equity of SLM Corp is shown below.

SLM Corp's ROE Trends Chart

source: finbox.io data explorer – ROE

It appears that the return on equity of SLM Corp has generally been increasing over the last few years. ROE decreased from 18.5% to 13.9% in fiscal year 2016, increased to 14.2% in 2017 and increased again to 15.0% as of LTM Mar’18. So what’s causing the general improvement?


SLM Corp’s Improving ROE Trends

In addition to the formula previously discussed, there’s actually another way to calculate ROE. It’s often called the DuPont formula and is as follows:

Return on Equity = Net Profit Margin * Asset Turnover * Equity Multiplier

Analyzing changes in these three items over time allows investors to figure out if operating efficiency, asset use efficiency or the use of leverage is what’s causing changes in ROE. Strong companies should have ROE that is increasing because its net profit margin and/or asset turnover is increasing. On the other hand, a company may not be as strong as investors would otherwise think if ROE is increasing from the use of leverage or debt.

So let’s take a closer look at the drivers behind SLM Corp’s returns.

Net Profit Margin

The net profit margin of SLM Corp has generally been declining over the last few years. Margins decreased from 25.5% to 20.0% in fiscal year 2016, decreased to 19.1% in 2017 and increased to 19.8% as of LTM Mar’18.

SLM Net Profit Margin Trends

source: data explorer – net profit margin

Therefore, the company’s ROE improvement is not as a result of its net profit margin performance which has generally been decreasing. Then could the increasing ROE be a result of improving efficiency?

Asset Turnover

It appears that asset turnover of SLM Corp has generally been increasing over the last few years. Turnover decreased from 0.07x to 0.07x in fiscal year 2016, increased to 0.07x in 2017 and increased again to 0.07x as of LTM Mar’18.

SLM Asset Turnover Trends

source: data explorer – asset turnover

Therefore, the company’s increasing asset turnover ratio helps explain, at least in part, why ROE is also increasing.

Finally, the DuPont constituents that make up SLM Corp’s ROE are shown in the table below. Note that the table also compares SLM Corp to a peer group that includes Nelnet, Inc. (NYSE: NNI), Ally Financial Inc. (NYSE: ALLY), Santander Consumer USA Holdings Inc. (NYSE: SC) and OneMain Holdings, Inc. (NYSE: OMF).

SLM ROE Breakdown vs Peers Table - DuPont Analysis

source: finbox.io’s DuPont model

In conclusion, the DuPont analysis has helped us better understand that SLM Corp’s general improvement in return on equity is the result of a worsening net profit margin, an improving asset turnover ratio and increasing leverage. Therefore when looking at the core operations of the business, SLM Corp shareholders may need to start worrying due to the company’s general decline in profitability along with a general improvement in operational efficiency and increasing leverage.

The DuPont approach is a helpful tool when analyzing how well management is utilizing shareholder capital. However, it doesn’t necessarily tell the whole story. If you have not done so already, I highly recommend that you complete your research on SLM Corp by taking a look at the following:

Valuation Metrics: how much upside do shares of SLM Corp have based on the Ben Graham Formula? Take a look at our Ben Graham Formula data explorer which also compares the company’s upside to its peers.

Risk Metrics: what is SLM Corp’s Altman Z score? It’s a famous formula used to predict the probability that a firm will go into bankruptcy within two years. View the company’s Altman Z score here.

Efficiency Metrics: how much free cash flow does SLM Corp generate as a percentage of total sales? Has it been increasing or decreasing over time? Review the firm’s free cash flow margin here.

As of this writing, I did not hold a position in any of the aforementioned securities and this is not a buy or sell recommendation on any security mentioned.

Expertise: Valuation, financial statement analysis. Matt Hogan is also a co-founder of finbox.io. His expertise is in investment decision making. Prior to finbox.io, Matt worked for an investment banking group providing fairness opinions in connection to stock acquisitions. He spent much of his time building valuation models to help clients determine an asset’s fair value. He believes that these same valuation models should be used by all investors before buying or selling a stock. His work is frequently published at InvestorPlace, Benzinga, ValueWalk, AAII, Barron’s, Seeking Alpha and investing.com. Matt can be reached at matt@finbox.io or at +1 (516) 778-6257.

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