Today we'll look at K12 Inc. (NYSE:LRN) 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.
Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. 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. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
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 K12:
0.059 = US$40m ÷ (US$813m - US$140m) (Based on the trailing twelve months to September 2019.)
Therefore, K12 has an ROCE of 5.9%.
Is K12's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In this analysis, K12's ROCE appears meaningfully below the 8.9% average reported by the Consumer Services industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how K12 stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.
In our analysis, K12's ROCE appears to be 5.9%, compared to 3 years ago, when its ROCE was 3.2%. This makes us think about whether the company has been reinvesting shrewdly. You can see in the image below how K12's ROCE compares to its industry. Click to see more on past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. ROCE is, after all, simply a snap shot of a single year. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
How K12's Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
K12 has total assets of US$813m and current liabilities of US$140m. As a result, its current liabilities are equal to approximately 17% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
What We Can Learn From K12's ROCE
If K12 continues to earn an uninspiring ROCE, there may be better places to invest. Of course, you might also be able to find a better stock than K12. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like K12 better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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.
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