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Today we'll look at Central Garden & Pet Company (NASDAQ:CENT) and reflect on its potential as an investment. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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.'
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 Central Garden & Pet:
0.088 = US$154m ÷ (US$2.0b - US$299m) (Based on the trailing twelve months to March 2019.)
So, Central Garden & Pet has an ROCE of 8.8%.
Is Central Garden & Pet's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. We can see Central Garden & Pet's ROCE is meaningfully below the Household Products industry average of 12%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Separate from how Central Garden & Pet stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.
You can click on the image below to see (in greater detail) how Central Garden & Pet's past growth compares to other companies.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect Central Garden & Pet's ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Central Garden & Pet has total liabilities of US$299m and total assets of US$2.0b. 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.
The Bottom Line On Central Garden & Pet's ROCE
If Central Garden & Pet continues to earn an uninspiring ROCE, there may be better places to invest. You might be able to find a better investment than Central Garden & Pet. 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 Central Garden & Pet better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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 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.