Today we'll evaluate Bright Horizons Family Solutions Inc. (NYSE:BFAM) 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.
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. 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 Bright Horizons Family Solutions:
0.096 = US$264m ÷ (US$3.2b - US$470m) (Based on the trailing twelve months to September 2019.)
Therefore, Bright Horizons Family Solutions has an ROCE of 9.6%.
Does Bright Horizons Family Solutions Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. It appears that Bright Horizons Family Solutions's ROCE is fairly close to the Consumer Services industry average of 9.4%. Setting aside the industry comparison for now, Bright Horizons Family Solutions's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
The image below shows how Bright Horizons Family Solutions's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Bright Horizons Family Solutions.
How Bright Horizons Family Solutions's Current Liabilities Impact Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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.
Bright Horizons Family Solutions has total assets of US$3.2b and current liabilities of US$470m. Therefore its current liabilities are equivalent to approximately 15% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
What We Can Learn From Bright Horizons Family Solutions's ROCE
With that in mind, we're not overly impressed with Bright Horizons Family Solutions's ROCE, so it may not be the most appealing prospect. 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.
If you are like me, then you will not want to miss this free list of growing companies that insiders are 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 firstname.lastname@example.org. 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.