Today we'll evaluate Ark Restaurants Corp. (NASDAQ:ARKR) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the 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 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?
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 Ark Restaurants:
0.099 = US$7.1m ÷ (US$90m - US$18m) (Based on the trailing twelve months to June 2019.)
So, Ark Restaurants has an ROCE of 9.9%.
Does Ark Restaurants Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Using our data, Ark Restaurants's ROCE appears to be around the 8.9% average of the Hospitality industry. Aside from the industry comparison, Ark Restaurants'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.
Ark Restaurants's current ROCE of 9.9% is lower than 3 years ago, when the company reported a 17% ROCE. Therefore we wonder if the company is facing new headwinds. You can see in the image below how Ark Restaurants's ROCE compares to its industry. Click to see more on past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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. You can check if Ark Restaurants has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Ark Restaurants's ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Ark Restaurants has total liabilities of US$18m and total assets of US$90m. As a result, its current liabilities are equal to approximately 20% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
What We Can Learn From Ark Restaurants's ROCE
With that in mind, we're not overly impressed with Ark Restaurants's ROCE, so it may not be the most appealing prospect. You might be able to find a better investment than Ark Restaurants. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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 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.