U.S. Markets open in 1 hr 50 mins

Should Cars.com Inc.’s (NYSE:CARS) Weak Investment Returns Worry You?

Simply Wall St

Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!

Today we'll evaluate Cars.com Inc. (NYSE:CARS) to determine whether it could have potential as an investment idea. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.

What is Return On Capital Employed (ROCE)?

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. In brief, it is a useful tool, but it is not without drawbacks. 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?

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 Cars.com:

0.036 = US$89m ÷ (US$2.6b - US$120m) (Based on the trailing twelve months to March 2019.)

Therefore, Cars.com has an ROCE of 3.6%.

View our latest analysis for Cars.com

Does Cars.com Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. We can see Cars.com's ROCE is meaningfully below the Interactive Media and Services industry average of 9.2%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Independently of how Cars.com compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.7% available in government bonds. There are potentially more appealing investments elsewhere.

Cars.com's current ROCE of 3.6% is lower than 3 years ago, when the company reported a 6.5% ROCE. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how Cars.com's past growth compares to other companies.

NYSE:CARS Past Revenue and Net Income, July 4th 2019

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Cars.com.

Do Cars.com's Current Liabilities Skew Its ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Cars.com has total liabilities of US$120m and total assets of US$2.6b. Therefore its current liabilities are equivalent to approximately 4.6% of its total assets. Cars.com has a low level of current liabilities, which have a negligible impact on its already low ROCE.

Our Take On Cars.com's ROCE

Nonetheless, there may be better places to invest your capital. You might be able to find a better investment than Cars.com. 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).

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 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.