Today we are going to look at The Children's Place, Inc. (NASDAQ:PLCE) to see whether it might be an attractive investment prospect. 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 of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. 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 Children's Place:
0.14 = US$88m ÷ (US$1.3b - US$674m) (Based on the trailing twelve months to August 2019.)
Therefore, Children's Place has an ROCE of 14%.
Is Children's Place's ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, we find that Children's Place's ROCE is meaningfully better than the 10% average in the Specialty Retail industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from Children's Place's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Children's Place's current ROCE of 14% is lower than its ROCE in the past, which was 23%, 3 years ago. This makes us wonder if the business is facing new challenges. You can see in the image below how Children's Place'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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for Children's Place.
What Are Current Liabilities, And How Do They Affect Children's Place's ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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.
Children's Place has total liabilities of US$674m and total assets of US$1.3b. As a result, its current liabilities are equal to approximately 52% of its total assets. This is admittedly a high level of current liabilities, improving ROCE substantially.
The Bottom Line On Children's Place's ROCE
While its ROCE looks decent, it wouldn't look so good if it reduced current liabilities. Children's Place shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
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 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. Thank you for reading.