Today we’ll look at Rocky Mountain Chocolate Factory, Inc. (NASDAQ:RMCF) 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.
First of all, we’ll work out how to calculate ROCE. Second, we’ll look at its ROCE compared 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. 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 Rocky Mountain Chocolate Factory:
0.18 = US$5.2m ÷ (US$28m – US$5.7m) (Based on the trailing twelve months to November 2018.)
So, Rocky Mountain Chocolate Factory has an ROCE of 18%.
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Does Rocky Mountain Chocolate Factory Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Rocky Mountain Chocolate Factory’s ROCE is meaningfully better than the 8.6% average in the Food industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how Rocky Mountain Chocolate Factory compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Rocky Mountain Chocolate Factory’s current ROCE of 18% is lower than its ROCE in the past, which was 26%, 3 years ago. This makes us wonder if the business is facing new challenges.
When considering this metric, keep in mind that it is backwards looking, and 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is Rocky Mountain Chocolate Factory? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Do Rocky Mountain Chocolate Factory’s Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Rocky Mountain Chocolate Factory has total liabilities of US$5.7m and total assets of US$28m. As a result, its current liabilities are equal to approximately 21% of its total assets. Low current liabilities are not boosting the ROCE too much.
Our Take On Rocky Mountain Chocolate Factory’s ROCE
Overall, Rocky Mountain Chocolate Factory has a decent ROCE and could be worthy of further research. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
I will like Rocky Mountain Chocolate Factory better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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 firstname.lastname@example.org.