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Why We’re Not Keen On DICK'S Sporting Goods, Inc.’s (NYSE:DKS) 8.6% Return On Capital

Simply Wall St

Today we'll look at DICK'S Sporting Goods, Inc. (NYSE:DKS) and reflect on its potential as an investment. 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.

Understanding 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'.

How Do You Calculate Return On Capital Employed?

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 DICK'S Sporting Goods:

0.086 = US$427m ÷ (US$6.9b - US$1.9b) (Based on the trailing twelve months to August 2019.)

Therefore, DICK'S Sporting Goods has an ROCE of 8.6%.

Check out our latest analysis for DICK'S Sporting Goods

Is DICK'S Sporting Goods's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, DICK'S Sporting Goods's ROCE appears to be significantly below the 12% average in the Specialty Retail industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how DICK'S Sporting Goods stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.

DICK'S Sporting Goods's current ROCE of 8.6% is lower than its ROCE in the past, which was 20%, 3 years ago. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how DICK'S Sporting Goods's past growth compares to other companies.

NYSE:DKS Past Revenue and Net Income, November 15th 2019

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. 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.

How DICK'S Sporting Goods'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. 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.

DICK'S Sporting Goods has total assets of US$6.9b and current liabilities of US$1.9b. Therefore its current liabilities are equivalent to approximately 28% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.

The Bottom Line On DICK'S Sporting Goods's ROCE

That said, DICK'S Sporting Goods's ROCE is mediocre, there may be more attractive investments around. You might be able to find a better investment than DICK'S Sporting Goods. 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).

There are plenty of other companies that have insiders buying up shares. You probably do not want to miss this free list of growing companies that insiders are buying.

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.