Today we’ll evaluate Big Lots, Inc. (NYSE:BIG) 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 up, we’ll look at what ROCE is and how we calculate it. 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’.
How Do You Calculate Return On Capital Employed?
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 Big Lots:
0.16 = US$222m ÷ (US$2.0b – US$639m) (Based on the trailing twelve months to February 2019.)
Therefore, Big Lots has an ROCE of 16%.
Does Big Lots Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. It appears that Big Lots’s ROCE is fairly close to the Multiline Retail industry average of 16%. Independently of how Big Lots compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Big Lots’s current ROCE of 16% is lower than 3 years ago, when the company reported a 25% ROCE. This makes us wonder if the business is facing new challenges.
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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Big Lots.
How Big Lots’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.
Big Lots has total liabilities of US$639m and total assets of US$2.0b. As a result, its current liabilities are equal to approximately 32% of its total assets. Big Lots has a middling amount of current liabilities, increasing its ROCE somewhat.
What We Can Learn From Big Lots’s ROCE
While its ROCE looks good, it’s worth remembering that the current liabilities are making the business look better. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.