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Today we'll look at Darden Restaurants, Inc. (NYSE:DRI) and reflect on its potential as an investment. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First, we'll go over how we 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.
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. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.
So, How Do We Calculate ROCE?
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 Darden Restaurants:
0.20 = US$861m ÷ (US$5.7b - US$1.4b) (Based on the trailing twelve months to February 2019.)
So, Darden Restaurants has an ROCE of 20%.
Does Darden Restaurants Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Darden Restaurants's ROCE is meaningfully better than the 9.4% average in the Hospitality industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where Darden Restaurants sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Darden Restaurants's Current Liabilities And Their Impact On Its 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Darden Restaurants has total liabilities of US$1.4b and total assets of US$5.7b. As a result, its current liabilities are equal to approximately 25% of its total assets. Low current liabilities are not boosting the ROCE too much.
Our Take On Darden Restaurants's ROCE
With that in mind, Darden Restaurants's ROCE appears pretty good. Darden Restaurants looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
I will like Darden Restaurants 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.