Today we are going to look at Educational Development Corporation (NASDAQ:EDUC) 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 of all, we’ll work out how to 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.
Return On Capital Employed (ROCE): What is it?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. 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?
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 Educational Development:
0.19 = US$7.4m ÷ (US$72m – US$26m) (Based on the trailing twelve months to November 2018.)
So, Educational Development has an ROCE of 19%.
Is Educational Development’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, Educational Development’s ROCE appears to be around the 16% average of the Retail Distributors industry. Independently of how Educational Development compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Educational Development’s current ROCE of 19% is lower than its ROCE in the past, which was 27%, 3 years ago. Therefore we wonder if the company is facing new headwinds.
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. You can check if Educational Development has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Educational Development’s Current Liabilities And Their Impact On Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. 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.
Educational Development has total liabilities of US$26m and total assets of US$72m. Therefore its current liabilities are equivalent to approximately 36% of its total assets. Educational Development has a middling amount of current liabilities, increasing its ROCE somewhat.
What We Can Learn From Educational Development’s ROCE
While its ROCE looks good, it’s worth remembering that the current liabilities are making the business look better. But note: Educational Development may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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 email@example.com.