Today we are going to look at Dunelm Group plc (LON:DNLM) to see whether it might be an attractive investment prospect. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
So, How Do We Calculate ROCE?
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 Dunelm Group:
0.32 = UK£148m ÷ (UK£664m - UK£207m) (Based on the trailing twelve months to December 2019.)
So, Dunelm Group has an ROCE of 32%.
Is Dunelm Group's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Dunelm Group's ROCE is meaningfully better than the 9.3% average in the Specialty 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, Dunelm Group's ROCE currently appears to be excellent.
Dunelm Group's current ROCE of 32% is lower than 3 years ago, when the company reported a 45% ROCE. This makes us wonder if the business is facing new challenges. You can click on the image below to see (in greater detail) how Dunelm Group's past growth compares to other companies.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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.
Do Dunelm Group's Current Liabilities Skew Its 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Dunelm Group has current liabilities of UK£207m and total assets of UK£664m. As a result, its current liabilities are equal to approximately 31% of its total assets. Dunelm Group's ROCE is boosted somewhat by its middling amount of current liabilities.
Our Take On Dunelm Group's ROCE
Despite this, it reports a high ROCE, and may be worth investigating further. Dunelm Group 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 Dunelm Group 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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