Today we are going to look at Stitch Fix, Inc. (NASDAQ:SFIX) 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.
Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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 Stitch Fix:
0.054 = US$23m ÷ (US$616m - US$183m) (Based on the trailing twelve months to August 2019.)
So, Stitch Fix has an ROCE of 5.4%.
Does Stitch Fix Have A Good ROCE?
One way to assess ROCE is to compare similar companies. It appears that Stitch Fix's ROCE is fairly close to the Online Retail industry average of 6.5%. Independently of how Stitch Fix 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.
Stitch Fix's current ROCE of 5.4% is lower than 3 years ago, when the company reported a 60% ROCE. So investors might consider if it has had issues recently. You can see in the image below how Stitch Fix's ROCE compares to its industry. Click to see more on past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during 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 Stitch Fix'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 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Stitch Fix has total liabilities of US$183m and total assets of US$616m. As a result, its current liabilities are equal to approximately 30% 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 Stitch Fix's ROCE
Stitch Fix has a poor ROCE, and there may be better investment prospects out there. You might be able to find a better investment than Stitch Fix. 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 like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.
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