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Why We’re Not Keen On Tile Shop Holdings, Inc.’s (NASDAQ:TTS) 7.6% Return On Capital

Simply Wall St

Today we’ll look at Tile Shop Holdings, Inc. (NASDAQ:TTS) and reflect on its potential as an investment. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.

First of all, we’ll work out how to calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. 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 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. In brief, it is a useful tool, but it is not without drawbacks. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’

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 Tile Shop Holdings:

0.076 = US$19m ÷ (US$298m – US$51m) (Based on the trailing twelve months to December 2018.)

So, Tile Shop Holdings has an ROCE of 7.6%.

View our latest analysis for Tile Shop Holdings

Is Tile Shop Holdings’s ROCE Good?

One way to assess ROCE is to compare similar companies. Using our data, Tile Shop Holdings’s ROCE appears to be significantly below the 13% average in the Specialty Retail industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Separate from how Tile Shop Holdings stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.

Tile Shop Holdings’s current ROCE of 7.6% is lower than 3 years ago, when the company reported a 15% ROCE. Therefore we wonder if the company is facing new headwinds.

NasdaqGS:TTS Past Revenue and Net Income, March 11th 2019

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Tile Shop Holdings.

Do Tile Shop Holdings’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 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Tile Shop Holdings has total liabilities of US$51m and total assets of US$298m. As a result, its current liabilities are equal to approximately 17% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.

Our Take On Tile Shop Holdings’s ROCE

With that in mind, we’re not overly impressed with Tile Shop Holdings’s ROCE, so it may not be the most appealing prospect. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.