Today we'll evaluate The Wendy's Company (NASDAQ:WEN) to determine whether it could have potential as an investment idea. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
What is 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. All else being equal, a better business will have a higher ROCE. 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.'
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 Wendy's:
0.057 = US$273m ÷ (US$5.2b - US$341m) (Based on the trailing twelve months to June 2019.)
Therefore, Wendy's has an ROCE of 5.7%.
Does Wendy's Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, Wendy's's ROCE appears meaningfully below the 9.2% average reported by the Hospitality industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Independently of how Wendy's compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.7% available in government bonds. Readers may wish to look for more rewarding investments.
You can see in the image below how Wendy's's ROCE compares to its industry. Click to see more on past growth.
When considering this metric, keep in mind that it is backwards looking, and 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. 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 Wendy's's Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
Wendy's has total liabilities of US$341m and total assets of US$5.2b. As a result, its current liabilities are equal to approximately 6.6% of its total assets. Wendy's has very few current liabilities, which have a minimal effect on its already low ROCE.
Our Take On Wendy's's ROCE
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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.