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Are Educational Development Corporation’s Returns On Capital Worth Investigating?

Simply Wall St

Today we'll evaluate Educational Development Corporation (NASDAQ:EDUC) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into 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. Finally, we'll look at how its current liabilities affect its ROCE.

What is 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. 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.'

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 Educational Development:

0.17 = US$7.9m ÷ (US$67m - US$20m) (Based on the trailing twelve months to May 2019.)

So, Educational Development has an ROCE of 17%.

See our latest analysis for Educational Development

Is Educational Development's ROCE Good?

One way to assess ROCE is to compare similar companies. Using our data, Educational Development's ROCE appears to be around the 16% average of the Retail Distributors industry. Regardless of where Educational Development sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

Our data shows that Educational Development currently has an ROCE of 17%, compared to its ROCE of 11% 3 years ago. This makes us wonder if the company is improving. You can see in the image below how Educational Development's ROCE compares to its industry. Click to see more on past growth.

NasdaqGM:EDUC Past Revenue and Net Income, August 5th 2019

It is important to remember that ROCE shows past performance, and is not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. You can check if Educational Development has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

Educational Development'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. 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.

Educational Development has total liabilities of US$20m and total assets of US$67m. As a result, its current liabilities are equal to approximately 30% of its total assets. With this level of current liabilities, Educational Development's ROCE is boosted somewhat.

What We Can Learn From Educational Development's ROCE

While its ROCE looks good, it's worth remembering that the current liabilities are making the business look better. Educational Development shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.

I will like Educational Development 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 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. Thank you for reading.