Today we are going to look at Dollarama Inc. (TSE:DOL) to see whether it might be an attractive investment prospect. 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.
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 is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for Dollarama:
0.30 = CA$811m ÷ (CA$3.4b - CA$691m) (Based on the trailing twelve months to May 2019.)
So, Dollarama has an ROCE of 30%.
Is Dollarama's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Dollarama's ROCE is meaningfully better than the 12% average in the Multiline Retail industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Regardless of the industry comparison, in absolute terms, Dollarama's ROCE currently appears to be excellent.
You can see in the image below how Dollarama's ROCE compares to its industry. Click to see more on past growth.
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. ROCE is only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Dollarama.
Dollarama's Current Liabilities And Their Impact On Its 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.
Dollarama has total assets of CA$3.4b and current liabilities of CA$691m. As a result, its current liabilities are equal to approximately 20% of its total assets. This is quite a low level of current liabilities which would not greatly boost the already high ROCE.
What We Can Learn From Dollarama's ROCE
Low current liabilities and high ROCE is a good combination, making Dollarama look quite interesting. Dollarama 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 Dollarama better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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