What Can We Make Of Tractor Supply Company’s (NASDAQ:TSCO) High Return On Capital?
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Today we'll look at Tractor Supply Company (NASDAQ:TSCO) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First up, we'll look at what ROCE is and how we calculate it. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting 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. All else being equal, a better business will have a higher ROCE. 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 Tractor Supply:
0.17 = US$710m ÷ (US$5.4b - US$1.3b) (Based on the trailing twelve months to March 2019.)
So, Tractor Supply has an ROCE of 17%.
View our latest analysis for Tractor Supply
Is Tractor Supply's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Tractor Supply's ROCE is meaningfully higher than the 12% 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. Separate from Tractor Supply's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Tractor Supply's current ROCE of 17% is lower than its ROCE in the past, which was 38%, 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. ROCE is, after all, simply a snap shot of a single year. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
How Tractor Supply's Current Liabilities Impact Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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.
Tractor Supply has total assets of US$5.4b and current liabilities of US$1.3b. Therefore its current liabilities are equivalent to approximately 24% of its total assets. Low current liabilities are not boosting the ROCE too much.
The Bottom Line On Tractor Supply's ROCE
This is good to see, and with a sound ROCE, Tractor Supply could be worth a closer look. Tractor Supply looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
I will like Tractor Supply better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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 editorial-team@simplywallst.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.
