Today we'll look at Texas Roadhouse, Inc. (NASDAQ:TXRH) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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 Texas Roadhouse:
0.13 = US$194m ÷ (US$1.9b - US$332m) (Based on the trailing twelve months to September 2019.)
Therefore, Texas Roadhouse has an ROCE of 13%.
Does Texas Roadhouse Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Texas Roadhouse's ROCE is meaningfully higher than the 8.5% average in the Hospitality industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where Texas Roadhouse sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Texas Roadhouse's current ROCE of 13% is lower than its ROCE in the past, which was 21%, 3 years ago. So investors might consider if it has had issues recently. The image below shows how Texas Roadhouse's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. 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 Texas Roadhouse'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 counter this, investors can check if a company has high current liabilities relative to total assets.
Texas Roadhouse has total assets of US$1.9b and current liabilities of US$332m. As a result, its current liabilities are equal to approximately 18% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
What We Can Learn From Texas Roadhouse's ROCE
With that in mind, Texas Roadhouse's ROCE appears pretty good. There might be better investments than Texas Roadhouse out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
If you spot an error that warrants correction, please contact the editor at email@example.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.
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