U.S. Markets closed

Why National Vision Holdings, Inc.’s (NASDAQ:EYE) Return On Capital Employed Looks Uninspiring

Simply Wall St

Today we'll evaluate National Vision Holdings, Inc. (NASDAQ:EYE) 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.

Firstly, we'll go over how we calculate ROCE. 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 is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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 National Vision Holdings:

0.04 = US$70m ÷ (US$2.1b - US$304m) (Based on the trailing twelve months to September 2019.)

So, National Vision Holdings has an ROCE of 4.0%.

Check out our latest analysis for National Vision Holdings

Does National Vision Holdings Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. We can see National Vision Holdings's ROCE is meaningfully below the Specialty Retail industry average of 10%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how National Vision Holdings 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 click on the image below to see (in greater detail) how National Vision Holdings's past growth compares to other companies.

NasdaqGS:EYE Past Revenue and Net Income, November 12th 2019

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Do National Vision Holdings's Current Liabilities Skew Its ROCE?

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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.

National Vision Holdings has total liabilities of US$304m and total assets of US$2.1b. Therefore its current liabilities are equivalent to approximately 15% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.

The Bottom Line On National Vision Holdings's ROCE

While that is good to see, National Vision Holdings has a low ROCE and does not look attractive in this analysis. Of course, you might also be able to find a better stock than National Vision Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.