Today we'll evaluate Lululemon Athletica Inc. (NASDAQ:LULU) to determine whether it could have potential as an investment idea. 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.
First of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the 'return' (pre-tax profit) a company generates from 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. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'
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 Lululemon Athletica:
0.37 = US$729m ÷ (US$2.5b - US$503m) (Based on the trailing twelve months to May 2019.)
So, Lululemon Athletica has an ROCE of 37%.
Does Lululemon Athletica Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Lululemon Athletica's ROCE appears to be substantially greater than the 12% average in the Luxury 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. Regardless of the industry comparison, in absolute terms, Lululemon Athletica's ROCE currently appears to be excellent.
We can see that , Lululemon Athletica currently has an ROCE of 37% compared to its ROCE 3 years ago, which was 30%. This makes us think the business might be improving. The image below shows how Lululemon Athletica's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. 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 Lululemon Athletica'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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Lululemon Athletica has total liabilities of US$503m and total assets of US$2.5b. Therefore its current liabilities are equivalent to approximately 20% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.
Our Take On Lululemon Athletica's ROCE
Low current liabilities and high ROCE is a good combination, making Lululemon Athletica look quite interesting. There might be better investments than Lululemon Athletica out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
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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.