Today we'll look at La-Z-Boy Incorporated (NYSE:LZB) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting 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. In general, businesses with a higher ROCE are usually better quality. 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'.
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 La-Z-Boy:
0.12 = US$129m ÷ (US$1.4b - US$318m) (Based on the trailing twelve months to October 2019.)
Therefore, La-Z-Boy has an ROCE of 12%.
Is La-Z-Boy's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. We can see La-Z-Boy's ROCE is around the 11% average reported by the Consumer Durables industry. Regardless of where La-Z-Boy sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
La-Z-Boy's current ROCE of 12% is lower than its ROCE in the past, which was 20%, 3 years ago. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how La-Z-Boy's past growth compares to other companies.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for La-Z-Boy.
How La-Z-Boy's Current Liabilities Impact 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 ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.
La-Z-Boy has total assets of US$1.4b and current liabilities of US$318m. As a result, its current liabilities are equal to approximately 23% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
Our Take On La-Z-Boy's ROCE
With that in mind, La-Z-Boy's ROCE appears pretty good. There might be better investments than La-Z-Boy out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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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