Canaf Investments Inc (CAF)

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Is Canaf Investments Inc’s (CVE:CAF) 18% ROE Strong Compared To Its Industry?

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Is Canaf Investments Inc’s (CVE:CAF) 18% ROE Strong Compared To Its Industry?
Kyle Sanford October 6, 2018
Many investors are still learning about the various metrics that can be useful when analysing a stock. This article is for those who would like to learn about Return On Equity (ROE). We’ll use ROE to examine Canaf Investments Inc (CVE:CAF), by way of a worked example.

Canaf Investments has a ROE of 18%, based on the last twelve months. One way to conceptualize this, is that for each CA$1 of shareholders’ equity it has, the company made CA$0.18 in profit.

Check out our latest analysis for Canaf Investments

How Do You Calculate Return On Equity?
The formula for ROE is:

Return on Equity = Net Profit ÷ Shareholders’ Equity

Or for Canaf Investments:

18% = US$462k ÷ US$3m (Based on the trailing twelve months to July 2018.)

Most readers would understand what net profit is, but it’s worth explaining the concept of shareholders’ equity. It is all earnings retained by the company, plus any capital paid in by shareholders. Shareholders’ equity can be calculated by subtracting the total liabilities of the company from the total assets of the company.

What Does Return On Equity Mean?
ROE looks at the amount a company earns relative to the money it has kept within the business. The ‘return’ is the amount earned after tax over the last twelve months. A higher profit will lead to a a higher ROE. So, all else equal, investors should like a high ROE. That means ROE can be used to compare two businesses.

Does Canaf Investments Have A Good Return On Equity?
By comparing a company’s ROE with its industry average, we can get a quick measure of how good it is. However, this method is only useful as a rough check, because companies do differ quite a bit within the same industry classification. As you can see in the graphic below, Canaf Investments has a higher ROE than the average (11%) in the metals and mining industry.

TSXV:CAF Last Perf October 5th 18
TSXV:CAF Last Perf October 5th 18
That’s clearly a positive. We think a high ROE, alone, is usually enough to justify further research into a company. One data point to check is if insiders have bought shares recently.

Why You Should Consider Debt When Looking At ROE
Virtually all companies need money to invest in the business, to grow profits. That cash can come from issuing shares, retained earnings, or debt. In the first and second cases, the ROE will reflect this use of cash for investment in the business. In the latter case, the debt used for growth will improve returns, but won’t affect the total equity. That will make the ROE look better than if no debt was used.

Combining Canaf Investments’s Debt And Its 18% Return On Equity
While Canaf Investments does have a tiny amount of debt, with debt to equity of just 0.069, we think the use of debt is very modest. The fact that it achieved a fairly good ROE with only modest debt suggests the business might be worth putting on your watchlist. Conservative use of debt to boost returns is usually a good move for shareholders, though it does leave the company more exposed to interest rate rises.

The Key Takeaway
Return on equity is useful for comparing the quality of different businesses. In my book the highest quality companies have high return on equity, despite low debt. All else being equal, a higher ROE is better.