Here’s why CAI International, Inc.’s (NYSE:CAI) Returns On Capital Matters So Much

Today we’ll evaluate CAI International, Inc. (NYSE:CAI) to determine whether it could have potential as an investment idea. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.

First up, we’ll look at what ROCE is and how we calculate it. Second, we’ll look at its ROCE compared to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that ‘one dollar invested in the company generates value of more than one dollar’.

So, How Do We Calculate ROCE?

The formula for calculating the return on capital employed is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)

Or for CAI International:

0.063 = US$160m ÷ (US$3.0b – US$407m) (Based on the trailing twelve months to September 2019.)

Therefore, CAI International has an ROCE of 6.3%.

View our latest analysis for CAI International

Is CAI International’s ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. In this analysis, CAI International’s ROCE appears meaningfully below the 9.4% average reported by the Trade Distributors industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Setting aside the industry comparison for now, CAI International’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.

In our analysis, CAI International’s ROCE appears to be 6.3%, compared to 3 years ago, when its ROCE was 3.4%. This makes us think the business might be improving. You can click on the image below to see (in greater detail) how CAI International’s past growth compares to other companies.

NYSE:CAI Past Revenue and Net Income, February 3rd 2020
NYSE:CAI Past Revenue and Net Income, February 3rd 2020

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for CAI International.

CAI International’s Current Liabilities And Their Impact On Its ROCE

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counter this, investors can check if a company has high current liabilities relative to total assets.

CAI International has current liabilities of US$407m and total assets of US$3.0b. Therefore its current liabilities are equivalent to approximately 14% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.

Our Take On CAI International’s ROCE

If CAI International continues to earn an uninspiring ROCE, there may be better places to invest. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.