Today we'll evaluate Card Factory plc (LON:CARD) to determine whether it could have potential as an investment idea. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'
How Do You Calculate Return On Capital Employed?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for Card Factory:
0.21 = UK£79m ÷ (UK£455m - UK£72m) (Based on the trailing twelve months to January 2019.)
So, Card Factory has an ROCE of 21%.
Is Card Factory's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Card Factory's ROCE is meaningfully higher than the 13% average in the Specialty Retail industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Putting aside its position relative to its industry for now, in absolute terms, Card Factory's ROCE is currently very good.
You can see in the image below how Card Factory's ROCE compares to its industry. Click to see more on past growth.
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. ROCE is only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect Card Factory's 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Card Factory has total liabilities of UK£72m and total assets of UK£455m. As a result, its current liabilities are equal to approximately 16% of its total assets. The fairly low level of current liabilities won't have much impact on the already great ROCE.
What We Can Learn From Card Factory's ROCE
With low current liabilities and a high ROCE, Card Factory could be worthy of further investigation. Card Factory looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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