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Is Etsy, Inc. (NASDAQ:ETSY) Investing Effectively In Its Business?

Peter Morris

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Today we’ll evaluate Etsy, Inc. (NASDAQ:ETSY) 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.

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 measures the amount of pre-tax profits a company can generate from the capital employed in its 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.’

So, How Do We Calculate ROCE?

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 Etsy:

0.088 = US$29m ÷ (US$907m – US$129m) (Based on the trailing twelve months to September 2018.)

So, Etsy has an ROCE of 8.8%.

See our latest analysis for Etsy

Does Etsy Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. It appears that Etsy’s ROCE is fairly close to the Online Retail industry average of 9.4%. Separate from how Etsy stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.

Etsy reported an ROCE of 8.8% — better than 3 years ago, when the company didn’t make a profit. That implies the business has been improving.

NasdaqGS:ETSY Past Revenue and Net Income, February 20th 2019
NasdaqGS:ETSY Past Revenue and Net Income, February 20th 2019

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 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 Etsy.

What Are Current Liabilities, And How Do They Affect Etsy’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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Etsy has total assets of US$907m and current liabilities of US$129m. Therefore its current liabilities are equivalent to approximately 14% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.

The Bottom Line On Etsy’s ROCE

That said, Etsy’s ROCE is mediocre, there may be more attractive investments around. But note: Etsy may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

If you are like me, then you will not want to miss this free list of growing companies that insiders are 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.