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Should Collins Foods Limited’s (ASX:CKF) Weak Investment Returns Worry You?

Simply Wall St

Today we are going to look at Collins Foods Limited (ASX:CKF) to see whether it might be an attractive investment prospect. 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. Last but not least, we'll look at what impact its current liabilities have on 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. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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 Collins Foods:

0.075 = AU$76m ÷ (AU$1.1b - AU$122m) (Based on the trailing twelve months to October 2019.)

Therefore, Collins Foods has an ROCE of 7.5%.

Check out our latest analysis for Collins Foods

Is Collins Foods's ROCE Good?

One way to assess ROCE is to compare similar companies. In this analysis, Collins Foods's ROCE appears meaningfully below the 12% average reported by the Hospitality industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Aside from the industry comparison, Collins Foods'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.

We can see that, Collins Foods currently has an ROCE of 7.5%, less than the 14% it reported 3 years ago. So investors might consider if it has had issues recently. You can see in the image below how Collins Foods's ROCE compares to its industry. Click to see more on past growth.

ASX:CKF Past Revenue and Net Income, January 1st 2020

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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Collins Foods's Current Liabilities And Their Impact On Its ROCE

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

Collins Foods has total assets of AU$1.1b and current liabilities of AU$122m. As a result, its current liabilities are equal to approximately 11% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.

The Bottom Line On Collins Foods's ROCE

With that in mind, we're not overly impressed with Collins Foods's ROCE, so it may not be the most appealing prospect. You might be able to find a better investment than Collins 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).

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.

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. Thank you for reading.