Today we'll look at JB Hi-Fi Limited (ASX:JBH) and reflect on its potential as an investment. 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. 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 measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. 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?
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 JB Hi-Fi:
0.23 = AU$381m ÷ (AU$2.5b - AU$927m) (Based on the trailing twelve months to June 2019.)
So, JB Hi-Fi has an ROCE of 24%.
Is JB Hi-Fi's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that JB Hi-Fi's ROCE is meaningfully better than the 16% average in the Specialty Retail industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Putting aside its position relative to its industry for now, in absolute terms, JB Hi-Fi's ROCE is currently very good.
JB Hi-Fi's current ROCE of 24% is lower than 3 years ago, when the company reported a 41% ROCE. This makes us wonder if the business is facing new challenges. You can click on the image below to see (in greater detail) how JB Hi-Fi's past growth compares to other companies.
When considering this metric, keep in mind that it is backwards looking, and 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. 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 JB Hi-Fi.
JB Hi-Fi's Current Liabilities And Their Impact On Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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.
JB Hi-Fi has total assets of AU$2.5b and current liabilities of AU$927m. Therefore its current liabilities are equivalent to approximately 36% of its total assets. JB Hi-Fi's ROCE is boosted somewhat by its middling amount of current liabilities.
The Bottom Line On JB Hi-Fi's ROCE
Despite this, it reports a high ROCE, and may be worth investigating further. JB Hi-Fi 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 are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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.
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. Thank you for reading.