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Today we'll evaluate Tile Shop Holdings, Inc. (NASDAQ:TTS) to determine whether it could have potential as an investment idea. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
Firstly, we'll go over how we 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 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. Overall, it is a valuable metric that has its flaws. 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?
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 Tile Shop Holdings:
0.045 = US$16m ÷ (US$431m - US$86m) (Based on the trailing twelve months to March 2019.)
Therefore, Tile Shop Holdings has an ROCE of 4.5%.
Is Tile Shop Holdings's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In this analysis, Tile Shop Holdings's ROCE appears meaningfully below the 13% average reported by the Specialty Retail industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Putting aside Tile Shop Holdings's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. It is likely that there are more attractive prospects out there.
As we can see, Tile Shop Holdings currently has an ROCE of 4.5%, less than the 18% it reported 3 years ago. This makes us wonder if the business is facing new challenges.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Tile Shop Holdings.
Do Tile Shop Holdings's Current Liabilities Skew Its ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Tile Shop Holdings has total assets of US$431m and current liabilities of US$86m. As a result, its current liabilities are equal to approximately 20% 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 Tile Shop Holdings's ROCE
That's not a bad thing, however Tile Shop Holdings has a weak ROCE and may not be an attractive investment. Of course, you might also be able to find a better stock than Tile Shop Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.