Why Caisse Régionale de Crédit Agricole Mutuel de Paris et d'Ile-de-France (EPA:CAF) Delivered An Inferior ROE Compared To The Industry

With an ROE of 4.61%, Caisse Régionale de Crédit Agricole Mutuel de Paris et d'Ile-de-France (ENXTPA:CAF) returned in-line to its own industry which delivered 4.79% over the past year. But what is more interesting is whether CAF can sustain or improve on this level of return. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of CAF's returns. View our latest analysis for Caisse Régionale de Crédit Agricole Mutuel de Paris et d'Ile-de-France

Breaking down Return on Equity

Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. An ROE of 4.61% implies €0.05 returned on every €1 invested, so the higher the return, the better. Investors that are diversifying their portfolio based on industry may want to maximise their return in the Regional Banks sector by choosing the highest returning stock. However, this can be misleading as each firm has different costs of equity and debt levels i.e. the more debt Caisse Régionale de Crédit Agricole Mutuel de Paris et d'Ile-de-France has, the higher ROE is pumped up in the short term, at the expense of long term interest payment burden.

Returns are usually compared to costs to measure the efficiency of capital. Caisse Régionale de Crédit Agricole Mutuel de Paris et d'Ile-de-France’s cost of equity is 8.50%. Given a discrepancy of -3.89% between return and cost, this indicated that Caisse Régionale de Crédit Agricole Mutuel de Paris et d'Ile-de-France may be paying more for its capital than what it’s generating in return. ROE can be broken down into three different ratios: net profit margin, asset turnover, and financial leverage. This is called the Dupont Formula:

Essentially, profit margin shows how much money the company makes after paying for all its expenses. Asset turnover shows how much revenue Caisse Régionale de Crédit Agricole Mutuel de Paris et d'Ile-de-France can generate with its current 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 Caisse Régionale de Crédit Agricole Mutuel de Paris et d'Ile-de-France’s debt-to-equity ratio to examine sustainability of its returns. The most recent ratio is 20.85%, which is sensible and indicates Caisse Régionale de Crédit Agricole Mutuel de Paris et d'Ile-de-France has not taken on too much leverage. Thus, we can conclude its below-average ROE may be a result of low debt, and Caisse Régionale de Crédit Agricole Mutuel de Paris et d'Ile-de-France still has room to increase leverage and grow future returns.

Next Steps:

ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Caisse Régionale de Crédit Agricole Mutuel de Paris et d'Ile-de-France’s below-industry ROE is disappointing, furthermore, its returns were not even high enough to cover its own cost of equity. Although, its appropriate level of leverage means investors can be more confident in the sustainability of Caisse Régionale de Crédit Agricole Mutuel de Paris et d'Ile-de-France’s return with a possible increase should the company decide to increase its debt levels. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.

For Caisse Régionale de Crédit Agricole Mutuel de Paris et d'Ile-de-France, I've compiled three fundamental factors you should look at:

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

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Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.