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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.
Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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 Travelzoo:
0.45 = US$11m ÷ (US$54m - US$28m) (Based on the trailing twelve months to September 2019.)
So, Travelzoo has an ROCE of 45%.
Is Travelzoo's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Travelzoo's ROCE appears to be substantially greater than the 9.1% average in the Interactive Media and Services industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Putting aside its position relative to its industry for now, in absolute terms, Travelzoo's ROCE is currently very good.
Our data shows that Travelzoo currently has an ROCE of 45%, compared to its ROCE of 34% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly. You can see in the image below how Travelzoo's ROCE compares to its industry. Click to see more on past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for Travelzoo.
How Travelzoo'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 ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counter this, investors can check if a company has high current liabilities relative to total assets.
Travelzoo has total assets of US$54m and current liabilities of US$28m. Therefore its current liabilities are equivalent to approximately 53% 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
In my book, this business could be worthy of further research. 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.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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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