With An ROE Of 32.93%, Has Canadian National Railway Company's (TSE:CNR) Management Done A Good Job?

Canadian National Railway Company (TSX:CNR) delivered an ROE of 32.93% over the past 12 months, which is an impressive feat relative to its industry average of 22.28% during the same period. Though, the impressiveness of CNR’s ROE is contingent on whether this industry-beating level can be sustained. This can be measured by looking at the company’s financial leverage. With more debt, CNR can invest even more and earn more money, thus pushing up its returns. However, ROE only measures returns against equity, not debt. This can be distorted, so let’s take a look at it further. See our latest analysis for Canadian National Railway

What you must know about ROE

Return on Equity (ROE) weighs Canadian National Railway’s profit against the level of its shareholders’ equity. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. Investors seeking to maximise their return in the Railroads industry may want to choose the highest returning stock. However, this can be deceiving as each company has varying costs of equity and debt levels, which could exaggeratedly push up ROE at the same time as accumulating high interest expense.

ROE is measured against cost of equity in order to determine the efficiency of Canadian National Railway’s equity capital deployed. Its cost of equity is 9.95%. Since Canadian National Railway’s return covers its cost in excess of 22.98%, its use of equity capital is efficient and likely to be sustainable. Simply put, Canadian National Railway pays less for its capital than what it generates in return. ROE can be split up into three useful ratios: net profit margin, asset turnover, and financial leverage. This is called the Dupont Formula:

The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. Asset turnover reveals how much revenue can be generated from Canadian National Railway’s asset base. Finally, financial leverage will be our main focus today. It shows how much of assets are funded by equity and can show how sustainable the company’s capital structure is. ROE can be inflated by disproportionately high levels of debt. This is also unsustainable due to the high interest cost that the company will also incur. Thus, we should look at Canadian National Railway’s debt-to-equity ratio to examine sustainability of its returns. The most recent ratio is 65.01%, which is sensible and indicates Canadian National Railway has not taken on too much leverage. Thus, we can conclude its above-average ROE is generated from its capacity to increase profit without a large debt burden.

Next Steps:

ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Canadian National Railway’s ROE is impressive relative to the industry average and also covers 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. Although ROE can be a useful metric, it is only a small part of diligent research.

For Canadian National Railway, there are three pertinent factors you should further examine below. Just a heads up - to access some parts of the Simply Wall St research tool you might be asked to create a free account, but it takes just one click and the information they provide is definitely worth it in my opinion.

• 1. Financial Health: Does it have a healthy balance sheet? Take a look at this free balance sheet analysis with six simple checks on key factors like leverage and risk.
• 2. Valuation: What is Canadian National Railway worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in this free research report helps visualize whether Canadian National Railway is currently mispriced by the market.
• 3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Canadian National Railway? Explore this interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!