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Why We’re Not Keen On Natural Grocers by Vitamin Cottage, Inc.’s (NYSE:NGVC) 7.5% Return On Capital

Simply Wall St

Today we'll evaluate Natural Grocers by Vitamin Cottage, Inc. (NYSE:NGVC) to determine whether it could have potential as an investment idea. 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, we'll go over how we 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 is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. 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 Natural Grocers by Vitamin Cottage:

0.075 = US$18m ÷ (US$320m - US$81m) (Based on the trailing twelve months to June 2019.)

So, Natural Grocers by Vitamin Cottage has an ROCE of 7.5%.

See our latest analysis for Natural Grocers by Vitamin Cottage

Does Natural Grocers by Vitamin Cottage Have A Good ROCE?

One way to assess ROCE is to compare similar companies. We can see Natural Grocers by Vitamin Cottage's ROCE is meaningfully below the Consumer Retailing industry average of 9.7%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Aside from the industry comparison, Natural Grocers by Vitamin Cottage's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.

Natural Grocers by Vitamin Cottage's current ROCE of 7.5% is lower than 3 years ago, when the company reported a 11% ROCE. Therefore we wonder if the company is facing new headwinds. You can see in the image below how Natural Grocers by Vitamin Cottage's ROCE compares to its industry. Click to see more on past growth.

NYSE:NGVC Past Revenue and Net Income, August 26th 2019
NYSE:NGVC Past Revenue and Net Income, August 26th 2019

It is important to remember that ROCE shows past performance, and is not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

How Natural Grocers by Vitamin Cottage'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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Natural Grocers by Vitamin Cottage has total assets of US$320m and current liabilities of US$81m. Therefore its current liabilities are equivalent to approximately 25% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.

The Bottom Line On Natural Grocers by Vitamin Cottage's ROCE

With that in mind, we're not overly impressed with Natural Grocers by Vitamin Cottage's ROCE, so it may not be the most appealing prospect. You might be able to find a better investment than Natural Grocers by Vitamin Cottage. 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 Natural Grocers by Vitamin Cottage better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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.