Here’s why DFS Furniture plc’s (LON:DFS) Returns On Capital Matters So Much
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Today we are going to look at DFS Furniture plc (LON:DFS) to see whether it might be an attractive investment prospect. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First, 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.
Return On Capital Employed (ROCE): What is it?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that ‘one dollar invested in the company generates value of more than one dollar’.
So, How Do We Calculate ROCE?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
Or for DFS Furniture:
0.089 = UK£48m ÷ (UK£774m – UK£236m) (Based on the trailing twelve months to July 2018.)
Therefore, DFS Furniture has an ROCE of 8.9%.
See our latest analysis for DFS Furniture
Is DFS Furniture’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, DFS Furniture’s ROCE appears to be significantly below the 18% average in the Consumer Durables industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Separate from how DFS Furniture stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.
DFS Furniture’s current ROCE of 8.9% is lower than 3 years ago, when the company reported a 15% ROCE. Therefore we wonder if the company is facing new headwinds.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. 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.
How DFS Furniture’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 counter this, investors can check if a company has high current liabilities relative to total assets.
DFS Furniture has total assets of UK£774m and current liabilities of UK£236m. Therefore its current liabilities are equivalent to approximately 31% of its total assets. DFS Furniture has a medium level of current liabilities, which would boost its ROCE somewhat.
Our Take On DFS Furniture’s ROCE
With this level of liabilities and a mediocre ROCE, there are potentially better investments out there. Of course you might be able to find a better stock than DFS Furniture. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.