Today we’ll look at Chuy’s Holdings, Inc. (NASDAQ:CHUY) and reflect on its potential as an investment. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its 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.
Return On Capital Employed (ROCE): What is it?
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. Ultimately, it is a useful but imperfect metric. 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?
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 Chuy’s Holdings:
0.073 = US$22m ÷ (US$275m – US$25m) (Based on the trailing twelve months to September 2018.)
So, Chuy’s Holdings has an ROCE of 7.3%.
Is Chuy’s Holdings’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Chuy’s Holdings’s ROCE appears to be significantly below the 10% average in the Hospitality industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Setting aside the industry comparison for now, Chuy’s Holdings’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
As we can see, Chuy’s Holdings currently has an ROCE of 7.3%, less than the 13% it reported 3 years ago. This makes us wonder if the business is facing new challenges.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Chuy’s Holdings.
Do Chuy’s Holdings’s Current Liabilities Skew 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Chuy’s Holdings has total assets of US$275m and current liabilities of US$25m. Therefore its current liabilities are equivalent to approximately 9.2% of its total assets. Chuy’s Holdings reports few current liabilities, which have a negligible impact on its unremarkable ROCE.
What We Can Learn From Chuy’s Holdings’s ROCE
Based on this information, Chuy’s Holdings appears to be a mediocre business. Of course you might be able to find a better stock than Chuy’s Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.