Today we'll look at Del Taco Restaurants, Inc. (NASDAQ:TACO) and reflect on its potential as an investment. 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 up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
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. 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 Del Taco Restaurants:
0.038 = US$33m ÷ (US$960m - US$78m) (Based on the trailing twelve months to September 2019.)
So, Del Taco Restaurants has an ROCE of 3.8%.
Is Del Taco Restaurants's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, Del Taco Restaurants's ROCE appears to be significantly below the 8.5% average in the Hospitality industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Putting aside Del Taco Restaurants's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. It is likely that there are more attractive prospects out there.
We can see that, Del Taco Restaurants currently has an ROCE of 3.8%, less than the 6.1% it reported 3 years ago. This makes us wonder if the business is facing new challenges. You can click on the image below to see (in greater detail) how Del Taco Restaurants's past growth compares to other companies.
When considering this metric, keep in mind that it is backwards looking, and 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 only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Del Taco Restaurants.
What Are Current Liabilities, And How Do They Affect Del Taco Restaurants's 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 ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Del Taco Restaurants has total liabilities of US$78m and total assets of US$960m. Therefore its current liabilities are equivalent to approximately 8.1% of its total assets. Del Taco Restaurants has a low level of current liabilities, which have a negligible impact on its already low ROCE.
What We Can Learn From Del Taco Restaurants's ROCE
Still, investors could probably find more attractive prospects with better performance out there. You might be able to find a better investment than Del Taco Restaurants. 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).
I will like Del Taco Restaurants better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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