U.S. Markets closed

Why Reading International, Inc.’s (NASDAQ:RDI) Return On Capital Employed Looks Uninspiring

Bryan Cramer

Want to participate in a short research study? Help shape the future of investing tools and receive a $20 prize!

Today we’ll evaluate Reading International, Inc. (NASDAQ:RDI) to determine whether it could have potential as an investment idea. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

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.

What is Return On Capital Employed (ROCE)?

ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its 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’.

So, How Do We Calculate ROCE?

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 Reading International:

0.064 = US$21m ÷ (US$436m – US$54m) (Based on the trailing twelve months to September 2018.)

So, Reading International has an ROCE of 6.4%.

Check out our latest analysis for Reading International

Does Reading International Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. We can see Reading International’s ROCE is meaningfully below the Entertainment industry average of 10%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Separate from how Reading International 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.

NasdaqCM:RDI Past Revenue and Net Income, February 25th 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 only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

What Are Current Liabilities, And How Do They Affect Reading International’s ROCE?

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counter this, investors can check if a company has high current liabilities relative to total assets.

Reading International has total liabilities of US$54m and total assets of US$436m. As a result, its current liabilities are equal to approximately 12% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.

Our Take On Reading International’s ROCE

With that in mind, we’re not overly impressed with Reading International’s ROCE, so it may not be the most appealing prospect. But note: Reading International may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

I will like Reading International 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.