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Why CarMax, Inc.’s (NYSE:KMX) Return On Capital Employed Might Be A Concern

Simply Wall St

Today we are going to look at CarMax, Inc. (NYSE:KMX) to see whether it might be an attractive investment prospect. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First of all, we’ll work out how to calculate ROCE. Next, we’ll compare it to others in its industry. Last but not least, we’ll look at what impact its current liabilities have on 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. 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?

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 CarMax:

0.067 = US$1.1b ÷ (US$18b – US$1.2b) (Based on the trailing twelve months to November 2018.)

Therefore, CarMax has an ROCE of 6.7%.

View our latest analysis for CarMax

Is CarMax’s ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. In this analysis, CarMax’s ROCE appears meaningfully below the 13% average reported by the Specialty Retail industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how CarMax stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.

NYSE:KMX Past Revenue and Net Income, March 5th 2019

It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for CarMax.

Do CarMax’s Current Liabilities Skew Its ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

CarMax has total assets of US$18b and current liabilities of US$1.2b. Therefore its current liabilities are equivalent to approximately 6.7% of its total assets. CarMax reports few current liabilities, which have a negligible impact on its unremarkable ROCE.

What We Can Learn From CarMax’s ROCE

If performance improves, then CarMax may be an OK investment, especially at the right valuation. You might be able to find a better buy than CarMax. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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.