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TOD'S S.p.A.’s (BIT:TOD) Investment Returns Are Lagging Its Industry

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Today we'll evaluate TOD'S S.p.A. (BIT:TOD) to determine whether it could have potential as an investment idea. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.

First up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect 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. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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?

The formula for calculating the return on capital employed is:

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Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

Or for TOD'S:

0.061 = €75m ÷ (€1.6b - €392m) (Based on the trailing twelve months to December 2018.)

So, TOD'S has an ROCE of 6.1%.

View our latest analysis for TOD'S

Is TOD'S's ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. Using our data, TOD'S's ROCE appears to be significantly below the 11% average in the Luxury industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Aside from the industry comparison, TOD'S's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.

TOD'S's current ROCE of 6.1% is lower than 3 years ago, when the company reported a 15% ROCE. This makes us wonder if the business is facing new challenges.

BIT:TOD Past Revenue and Net Income, June 4th 2019
BIT:TOD Past Revenue and Net Income, June 4th 2019

It is important to remember that ROCE shows past performance, and is not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for TOD'S.

What Are Current Liabilities, And How Do They Affect TOD'S's ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counter this, investors can check if a company has high current liabilities relative to total assets.

TOD'S has total assets of €1.6b and current liabilities of €392m. As a result, its current liabilities are equal to approximately 24% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.

The Bottom Line On TOD'S's ROCE

If TOD'S continues to earn an uninspiring ROCE, there may be better places to invest. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.