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Why You Should Care About Culp, Inc.’s (NYSE:CULP) Low Return On Capital

Simply Wall St

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Today we'll evaluate Culp, Inc. (NYSE:CULP) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First, 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.

Understanding Return On Capital Employed (ROCE)

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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'.

How Do You Calculate Return On Capital Employed?

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 Culp:

0.082 = US$15m ÷ (US$220m - US$35m) (Based on the trailing twelve months to April 2019.)

So, Culp has an ROCE of 8.2%.

View our latest analysis for Culp

Does Culp Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. In this analysis, Culp's ROCE appears meaningfully below the 12% average reported by the Luxury industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Separate from how Culp stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.

Culp's current ROCE of 8.2% is lower than 3 years ago, when the company reported a 20% ROCE. So investors might consider if it has had issues recently. The image below shows how Culp's ROCE compares to its industry, and you can click it to see more detail on its past growth.

NYSE:CULP Past Revenue and Net Income, July 18th 2019

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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Culp.

What Are Current Liabilities, And How Do They Affect Culp'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 the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counter this, investors can check if a company has high current liabilities relative to total assets.

Culp has total liabilities of US$35m and total assets of US$220m. As a result, its current liabilities are equal to approximately 16% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.

The Bottom Line On Culp's ROCE

That said, Culp's ROCE is mediocre, there may be more attractive investments around. Of course, you might also be able to find a better stock than Culp. 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 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.