Today we are going to look at Emmis Communications Corporation (NASDAQ:EMMS) to see whether it might be an attractive investment prospect. 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. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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?
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 Emmis Communications:
0.058 = US$13m ÷ (US$256m - US$34m) (Based on the trailing twelve months to August 2019.)
So, Emmis Communications has an ROCE of 5.8%.
Is Emmis Communications's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. We can see Emmis Communications's ROCE is meaningfully below the Media industry average of 9.0%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Setting aside the industry comparison for now, Emmis Communications's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.
Emmis Communications's current ROCE of 5.8% is lower than 3 years ago, when the company reported a 11% ROCE. So investors might consider if it has had issues recently. The image below shows how Emmis Communications's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. You can check if Emmis Communications has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Emmis Communications'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. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Emmis Communications has total liabilities of US$34m and total assets of US$256m. Therefore its current liabilities are equivalent to approximately 13% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
Our Take On Emmis Communications's ROCE
With that in mind, we're not overly impressed with Emmis Communications's ROCE, so it may not be the most appealing prospect. Of course, you might also be able to find a better stock than Emmis Communications. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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.
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