Today we are going to look at Sleep Number Corporation (NASDAQ:SNBR) 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. 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 measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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'.
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 Sleep Number:
0.51 = US$103m ÷ (US$796m - US$593m) (Based on the trailing twelve months to June 2019.)
Therefore, Sleep Number has an ROCE of 51%.
Is Sleep Number's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Sleep Number's ROCE is meaningfully better than the 10% average in the Specialty Retail 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, Sleep Number's ROCE is currently very good.
We can see that, Sleep Number currently has an ROCE of 51% compared to its ROCE 3 years ago, which was 16%. This makes us think the business might be improving. The image below shows how Sleep Number's ROCE compares to its industry, and you can click it to see more detail on its past growth.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
How Sleep Number'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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Sleep Number has total assets of US$796m and current liabilities of US$593m. Therefore its current liabilities are equivalent to approximately 74% of its total assets. Sleep Number's high level of current liabilities boost the ROCE - but its ROCE is still impressive.
What We Can Learn From Sleep Number's ROCE
So to us, the company is potentially worth investigating further. There might be better investments than Sleep Number 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 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.