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Why Pizza Pizza Royalty Corp.’s (TSE:PZA) Return On Capital Employed Is Impressive

Simply Wall St

Today we'll look at Pizza Pizza Royalty Corp. (TSE:PZA) 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, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the amount of pre-tax profits a company can generate from the capital employed 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. 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 Pizza Pizza Royalty:

0.099 = CA$35m ÷ (CA$358m - CA$2.9m) (Based on the trailing twelve months to June 2019.)

Therefore, Pizza Pizza Royalty has an ROCE of 9.9%.

See our latest analysis for Pizza Pizza Royalty

Does Pizza Pizza Royalty Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Pizza Pizza Royalty's ROCE is meaningfully better than the 7.9% average in the Hospitality industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Separate from how Pizza Pizza Royalty stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.

The image below shows how Pizza Pizza Royalty's ROCE compares to its industry, and you can click it to see more detail on its past growth.

TSX:PZA Past Revenue and Net Income, August 12th 2019

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. 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.

Do Pizza Pizza Royalty's Current Liabilities Skew 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.

Pizza Pizza Royalty has total liabilities of CA$2.9m and total assets of CA$358m. Therefore its current liabilities are equivalent to approximately 0.8% of its total assets. Pizza Pizza Royalty has a low level of current liabilities, which have a minimal impact on its uninspiring ROCE.

The Bottom Line On Pizza Pizza Royalty's ROCE

Pizza Pizza Royalty looks like an ok business, but on this analysis it is not at the top of our buy list. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

If you are like me, then you will 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.