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Today we are going to look at Truett-Hurst, Inc. (NASDAQ:THST) 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.
Firstly, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Finally, we’ll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. 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 Truett-Hurst:
0.023 = US$122k ÷ (US$20m – US$2.6m) (Based on the trailing twelve months to September 2018.)
Therefore, Truett-Hurst has an ROCE of 2.3%.
Does Truett-Hurst Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. We can see Truett-Hurst’s ROCE is meaningfully below the Beverage industry average of 8.6%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how Truett-Hurst compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.7% available in government bonds. It is likely that there are more attractive prospects out there.
Truett-Hurst delivered an ROCE of 2.3%, which is better than 3 years ago, as was making losses back then. That suggests the business has returned to profitability.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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. If Truett-Hurst is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Truett-Hurst’s ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Truett-Hurst has total liabilities of US$2.6m and total assets of US$20m. Therefore its current liabilities are equivalent to approximately 13% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.
What We Can Learn From Truett-Hurst’s ROCE
Truett-Hurst has a poor ROCE, and there may be better investment prospects out there. Of course you might be able to find a better stock than Truett-Hurst. So you may wish to see this free collection of other companies that have grown earnings strongly.
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 firstname.lastname@example.org.