Today we'll look at Travelzoo (NASDAQ:TZOO) 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. Finally, we'll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. 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?
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 Travelzoo:
0.43 = US$11m ÷ (US$56m - US$30m) (Based on the trailing twelve months to June 2019.)
So, Travelzoo has an ROCE of 43%.
Does Travelzoo Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Travelzoo's ROCE appears to be substantially greater than the 8.7% average in the Interactive Media and Services industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of the industry comparison, in absolute terms, Travelzoo's ROCE currently appears to be excellent.
In our analysis, Travelzoo's ROCE appears to be 43%, compared to 3 years ago, when its ROCE was 32%. This makes us wonder if the company is improving. The image below shows how Travelzoo's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Do Travelzoo's Current Liabilities Skew 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. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Travelzoo has total liabilities of US$30m and total assets of US$56m. Therefore its current liabilities are equivalent to approximately 54% of its total assets. While a high level of current liabilities boosts its ROCE, Travelzoo's returns are still very good.
What We Can Learn From Travelzoo's ROCE
So we would be interested in doing more research here -- there may be an opportunity! There might be better investments than Travelzoo 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.