Today we'll look at Card Factory plc (LON:CARD) and reflect on its potential as an investment. 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 of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.
Return On Capital Employed (ROCE): What is it?
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. 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.
So, How Do We Calculate ROCE?
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:
0.15 = UK£75m ÷ (UK£603m - UK£99m) (Based on the trailing twelve months to July 2019.)
Therefore, Card Factory has an ROCE of 15%.
Does Card Factory Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Card Factory's ROCE appears to be substantially greater than the 8.6% average in the Specialty Retail industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where Card Factory sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
We can see that, Card Factory currently has an ROCE of 15%, less than the 21% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds. The image below shows how Card Factory's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
How Card Factory's Current Liabilities Impact Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Card Factory has current liabilities of UK£99m and total assets of UK£603m. As a result, its current liabilities are equal to approximately 16% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
What We Can Learn From Card Factory's ROCE
With that in mind, Card Factory's ROCE appears pretty good. Card Factory shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.
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