Today we'll look at America's Car-Mart, Inc. (NASDAQ:CRMT) 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.
Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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?
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 America's Car-Mart:
0.14 = US$75m ÷ (US$549m - US$32m) (Based on the trailing twelve months to July 2019.)
So, America's Car-Mart has an ROCE of 14%.
Does America's Car-Mart Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, America's Car-Mart's ROCE is meaningfully higher than the 10% average in the Specialty Retail industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how America's Car-Mart compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
We can see that, America's Car-Mart currently has an ROCE of 14% compared to its ROCE 3 years ago, which was 6.8%. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how America's Car-Mart's past growth compares to other companies.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. 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 America's Car-Mart.
Do America's Car-Mart's Current Liabilities Skew Its ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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.
America's Car-Mart has total assets of US$549m and current liabilities of US$32m. Therefore its current liabilities are equivalent to approximately 5.9% of its total assets. In addition to low current liabilities (making a negligible impact on ROCE), America's Car-Mart earns a sound return on capital employed.
What We Can Learn From America's Car-Mart's ROCE
If America's Car-Mart can continue reinvesting in its business, it could be an attractive prospect. America's Car-Mart 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.
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If you spot an error that warrants correction, please contact the editor at email@example.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.