Today we'll evaluate America's Car-Mart, Inc. (NASDAQ:CRMT) 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.
First, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. 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 America's Car-Mart:
0.11 = US$72m ÷ (US$667m - US$33m) (Based on the trailing twelve months to April 2020.)
Therefore, America's Car-Mart has an ROCE of 11%.
Is America's Car-Mart's ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, America's Car-Mart's ROCE appears to be around the 9.5% average of the Specialty Retail industry. Separate from America's Car-Mart's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
You can click on the image below to see (in greater detail) how America's Car-Mart's past growth compares to other companies.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for America's Car-Mart.
What Are Current Liabilities, And How Do They Affect America's Car-Mart's ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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.
America's Car-Mart has current liabilities of US$33m and total assets of US$667m. As a result, its current liabilities are equal to approximately 5.0% of its total assets. Low current liabilities have only a minimal impact on America's Car-Mart's ROCE, making its decent returns more credible.
The Bottom Line On America's Car-Mart's ROCE
This is good to see, and while better prospects may exist, America's Car-Mart seems worth researching further. There might be better investments than America's Car-Mart out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
America's Car-Mart is not the only stock insiders are buying. So take a peek at this free list of growing companies with insider buying.
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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.