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Today we’ll evaluate Famous Dave’s of America, Inc. (NASDAQ:DAVE) to determine whether it could have potential as an investment idea. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First up, we’ll look at what ROCE is and how we calculate it. Second, we’ll look at its ROCE compared to similar companies. Then we’ll determine how its current liabilities are affecting 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. 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?
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 Famous Dave’s of America:
0.20 = US$83k ÷ (US$38m – US$9.5m) (Based on the trailing twelve months to September 2018.)
So, Famous Dave’s of America has an ROCE of 20%.
Is Famous Dave’s of America’s ROCE Good?
One way to assess ROCE is to compare similar companies. Famous Dave’s of America’s ROCE appears to be substantially greater than the 9.7% average in the Hospitality industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where Famous Dave’s of America sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
In our analysis, Famous Dave’s of America’s ROCE appears to be 20%, compared to 3 years ago, when its ROCE was 3.8%. This makes us think the business might be improving.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect Famous Dave’s of America’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. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Famous Dave’s of America has total assets of US$38m and current liabilities of US$9.5m. Therefore its current liabilities are equivalent to approximately 25% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
What We Can Learn From Famous Dave’s of America’s ROCE
Overall, Famous Dave’s of America has a decent ROCE and could be worthy of further research. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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 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.