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Today we are going to look at Acorn International, Inc. (NYSE:ATV) to see whether it might be an attractive investment prospect. 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, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. 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.'
So, How Do We Calculate ROCE?
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 Acorn International:
0.045 = US$3.5m ÷ (US$94m - US$16m) (Based on the trailing twelve months to March 2019.)
Therefore, Acorn International has an ROCE of 4.5%.
Does Acorn International Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Using our data, Acorn International's ROCE appears to be significantly below the 8.1% average in the Online Retail industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how Acorn International compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.7% available in government bonds. It is likely that there are more attractive prospects out there.
Acorn International has an ROCE of 4.5%, but it didn't have an ROCE 3 years ago, since it was unprofitable. This makes us wonder if the company is improving. You can see in the image below how Acorn International's ROCE compares to its industry. Click to see more on past growth.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. You can check if Acorn International has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Acorn International's Current Liabilities And Their Impact On Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Acorn International has total liabilities of US$16m and total assets of US$94m. As a result, its current liabilities are equal to approximately 17% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.
The Bottom Line On Acorn International's ROCE
That's not a bad thing, however Acorn International has a weak ROCE and may not be an attractive investment. You might be able to find a better investment than Acorn International. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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.