Today we’ll evaluate Nathan’s Famous, Inc. (NASDAQ:NATH) to determine whether it could have potential as an investment idea. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First of all, we’ll work out how to calculate ROCE. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect 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. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. 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 Nathan’s Famous:
0.39 = US$27m ÷ (US$86m – US$16m) (Based on the trailing twelve months to September 2018.)
Therefore, Nathan’s Famous has an ROCE of 39%.
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Does Nathan’s Famous Have A Good ROCE?
One way to assess ROCE is to compare similar companies. In our analysis, Nathan’s Famous’s ROCE is meaningfully higher than the 10% average in the Hospitality 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, Nathan’s Famous’s ROCE is currently very good.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. You can check if Nathan’s Famous has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
How Nathan’s Famous’s Current Liabilities Impact 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.
Nathan’s Famous has total liabilities of US$16m and total assets of US$86m. As a result, its current liabilities are equal to approximately 19% of its total assets. This is quite a low level of current liabilities which would not greatly boost the already high ROCE.
The Bottom Line On Nathan’s Famous’s ROCE
With low current liabilities and a high ROCE, Nathan’s Famous could be worthy of further investigation. Of course you might be able to find a better stock than Nathan’s Famous. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.