What You Must Know About CAI International Inc's (NYSE:CAI) 12.78% ROE

CAI International Inc (NYSE:CAI) delivered an ROE of 12.78% over the past 12 months, which is relatively in-line with its industry average of 13.28% during the same period. But what is more interesting is whether CAI 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 CAI's returns. View our latest analysis for CAI International

What you must know about ROE

Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. Investors that are diversifying their portfolio based on industry may want to maximise their return in the Trading Companies and Distributors sector by choosing the highest returning stock. But this can be misleading as each company has different costs of equity and also varying debt levels, which could artificially push up ROE whilst accumulating high interest expense.

ROE is assessed against cost of equity, which is measured using the Capital Asset Pricing Model (CAPM) – but let’s not dive into the details of that today. For now, let’s just look at the cost of equity number for CAI International, which is 17.53%. This means CAI International’s returns actually do not cover its own cost of equity, with a discrepancy of -4.75%. This isn’t sustainable as it implies, very simply, that the company pays more for its capital than what it generates 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:

Basically, profit margin measures how much of revenue trickles down into earnings which illustrates how efficient the business is with its cost management. Asset turnover reveals how much revenue can be generated from CAI International’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. We can determine if CAI International’s ROE is inflated by borrowing high levels of debt. Generally, a balanced capital structure means its returns will be sustainable over the long run. We can examine this by looking at CAI International’s debt-to-equity ratio. Currently the ratio stands at more than 2.5 times, which is very high. This is not a good sign given CAI International's below-average ROE is already being driven by its significant debt levels and its ability to grow profit hinges on a significant debt burden.

Next Steps:

While ROE is a relatively simple calculation, it can be broken down into different ratios, each telling a different story about the strengths and weaknesses of a company. CAI International’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 CAI International’s return with a possible increase should the company decide to increase its debt levels. Although ROE can be a useful metric, it is only a small part of diligent research.

For CAI International, there are three relevant aspects 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. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for CAI International's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
• 3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of CAI International? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!