Today we'll evaluate Nordstrom, Inc. (NYSE:JWN) 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, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on 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. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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?
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 Nordstrom:
0.20 = US$909m ÷ (US$7.9b - US$3.4b) (Based on the trailing twelve months to February 2019.)
So, Nordstrom has an ROCE of 20%.
Is Nordstrom's ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, we find that Nordstrom's ROCE is meaningfully better than the 16% average in the Multiline Retail 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. Independently of how Nordstrom compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
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 Nordstrom.
How Nordstrom's Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Nordstrom has total assets of US$7.9b and current liabilities of US$3.4b. Therefore its current liabilities are equivalent to approximately 43% of its total assets. With this level of current liabilities, Nordstrom's ROCE is boosted somewhat.
What We Can Learn From Nordstrom's ROCE
While its ROCE looks good, it's worth remembering that the current liabilities are making the business look better. Nordstrom shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
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 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.