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Today we’ll evaluate Flexsteel Industries, Inc. (NASDAQ:FLXS) to determine whether it could have potential as an investment idea. 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. Then we’ll compare its ROCE to similar companies. Then we’ll determine how its current liabilities are affecting 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. 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’.
How Do You Calculate Return On Capital Employed?
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 Flexsteel Industries:
0.087 = US$26m ÷ (US$287m – US$44m) (Based on the trailing twelve months to September 2018.)
So, Flexsteel Industries has an ROCE of 8.7%.
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Does Flexsteel Industries Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, Flexsteel Industries’s ROCE appears meaningfully below the 11% average reported by the Consumer Durables industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Aside from the industry comparison, Flexsteel Industries’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
Flexsteel Industries’s current ROCE of 8.7% is lower than its ROCE in the past, which was 19%, 3 years ago. This makes us wonder if the business is facing new challenges.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. You can check if Flexsteel Industries has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Do Flexsteel Industries’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.
Flexsteel Industries has total assets of US$287m and current liabilities of US$44m. Therefore its current liabilities are equivalent to approximately 15% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
Our Take On Flexsteel Industries’s ROCE
That said, Flexsteel Industries’s ROCE is mediocre, there may be more attractive investments around. Of course you might be able to find a better stock than Flexsteel Industries. 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.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.