Today we’ll evaluate Cal-Maine Foods, Inc. (NASDAQ:CALM) to determine whether it could have potential as an investment idea. 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.
First of all, we’ll work out how to calculate ROCE. Next, we’ll compare it to others in its industry. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the 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.’
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 Cal-Maine Foods:
0.20 = US$184m ÷ (US$1.2b – US$97m) (Based on the trailing twelve months to December 2018.)
So, Cal-Maine Foods has an ROCE of 20%.
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Does Cal-Maine Foods Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that Cal-Maine Foods’s ROCE is meaningfully better than the 8.6% average in the Food industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Separate from Cal-Maine Foods’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Cal-Maine Foods’s current ROCE of 20% is lower than its ROCE in the past, which was 55%, 3 years ago. Therefore we wonder if the company is facing new headwinds.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Cal-Maine Foods.
What Are Current Liabilities, And How Do They Affect Cal-Maine Foods’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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Cal-Maine Foods has total liabilities of US$97m and total assets of US$1.2b. Therefore its current liabilities are equivalent to approximately 8.4% of its total assets. Low current liabilities have only a minimal impact on Cal-Maine Foods’s ROCE, making its decent returns more credible.
Our Take On Cal-Maine Foods’s ROCE
This is good to see, and while better prospects may exist, Cal-Maine Foods seems worth researching further. You might be able to find a better buy than Cal-Maine Foods. 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).
I will like Cal-Maine Foods better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.