Today we'll evaluate Ethan Allen Interiors Inc. (NYSE:ETH) to determine whether it could have potential as an investment idea. 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. Then we'll compare its ROCE to similar companies. 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 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. 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?
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 Ethan Allen Interiors:
0.14 = US$54m ÷ (US$510m - US$123m) (Based on the trailing twelve months to June 2019.)
Therefore, Ethan Allen Interiors has an ROCE of 14%.
Is Ethan Allen Interiors's ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, Ethan Allen Interiors's ROCE appears to be around the 13% average of the Consumer Durables industry. Regardless of where Ethan Allen Interiors sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Ethan Allen Interiors's current ROCE of 14% is lower than 3 years ago, when the company reported a 20% ROCE. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how Ethan Allen Interiors'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 only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Ethan Allen Interiors.
What Are Current Liabilities, And How Do They Affect Ethan Allen Interiors's 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Ethan Allen Interiors has total assets of US$510m and current liabilities of US$123m. Therefore its current liabilities are equivalent to approximately 24% of its total assets. Low current liabilities are not boosting the ROCE too much.
The Bottom Line On Ethan Allen Interiors's ROCE
This is good to see, and with a sound ROCE, Ethan Allen Interiors could be worth a closer look. Ethan Allen Interiors looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
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 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. Thank you for reading.