Today we’ll look at Good Times Restaurants Inc. (NASDAQ:GTIM) and reflect on its potential as an investment. 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. Next, we’ll compare it to others in its industry. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. 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.’
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 Good Times Restaurants:
0.0078 = US$409k ÷ (US$61m – US$8.3m) (Based on the trailing twelve months to September 2018.)
So, Good Times Restaurants has an ROCE of 0.8%.
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Does Good Times Restaurants Have A Good ROCE?
One way to assess ROCE is to compare similar companies. In this analysis, Good Times Restaurants’s ROCE appears meaningfully below the 10% average reported by the Hospitality industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how Good Times Restaurants compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.9% available in government bonds. It is likely that there are more attractive prospects out there.
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. ROCE is, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Good Times Restaurants.
How Good Times Restaurants’s Current Liabilities Impact 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. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Good Times Restaurants has total liabilities of US$8.3m and total assets of US$61m. Therefore its current liabilities are equivalent to approximately 14% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.
Our Take On Good Times Restaurants’s ROCE
While that is good to see, Good Times Restaurants has a low ROCE and does not look attractive in this analysis. You might be able to find a better buy than Good Times 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 Good Times 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.
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 email@example.com.