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Has Arcos Dorados Holdings Inc. (NYSE:ARCO) Been Employing Capital Shrewdly?

Simply Wall St

Today we are going to look at Arcos Dorados Holdings Inc. (NYSE:ARCO) 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. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. 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 Arcos Dorados Holdings:

0.085 = US$160m ÷ (US$2.4b - US$522m) (Based on the trailing twelve months to June 2019.)

Therefore, Arcos Dorados Holdings has an ROCE of 8.5%.

Check out our latest analysis for Arcos Dorados Holdings

Is Arcos Dorados Holdings's ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. It appears that Arcos Dorados Holdings's ROCE is fairly close to the Hospitality industry average of 8.5%. Setting aside the industry comparison for now, Arcos Dorados Holdings's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.

Arcos Dorados Holdings's current ROCE of 8.5% is lower than its ROCE in the past, which was 15%, 3 years ago. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how Arcos Dorados Holdings's past growth compares to other companies.

NYSE:ARCO Past Revenue and Net Income, November 14th 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. ROCE is, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for Arcos Dorados Holdings.

How Arcos Dorados Holdings's Current Liabilities Impact 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 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Arcos Dorados Holdings has total liabilities of US$522m and total assets of US$2.4b. As a result, its current liabilities are equal to approximately 22% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.

Our Take On Arcos Dorados Holdings's ROCE

If Arcos Dorados Holdings 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).

I will like Arcos Dorados Holdings better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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.