Today we are going to look at Foot Locker, Inc. (NYSE:FL) to see whether it might be an attractive investment prospect. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
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.
Understanding Return On Capital Employed (ROCE)
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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?
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 Foot Locker:
0.13 = US$726m ÷ (US$6.6b - US$1.2b) (Based on the trailing twelve months to November 2019.)
Therefore, Foot Locker has an ROCE of 13%.
Is Foot Locker's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Foot Locker's ROCE appears to be substantially greater than the 11% average in the Specialty Retail industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Separate from Foot Locker's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
We can see that, Foot Locker currently has an ROCE of 13%, less than the 31% it reported 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 Foot Locker's past growth compares to other companies.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Foot Locker.
Do Foot Locker'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 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.
Foot Locker has total liabilities of US$1.2b and total assets of US$6.6b. Therefore its current liabilities are equivalent to approximately 19% of its total assets. Low current liabilities are not boosting the ROCE too much.
What We Can Learn From Foot Locker's ROCE
This is good to see, and with a sound ROCE, Foot Locker could be worth a closer look. Foot Locker 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 Foot Locker better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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