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Why Tilly's, Inc.’s (NYSE:TLYS) Return On Capital Employed Looks Uninspiring

Simply Wall St

Today we are going to look at Tilly's, Inc. (NYSE:TLYS) to see whether it might be an attractive investment prospect. 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. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect 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. Ultimately, it is a useful but imperfect metric. 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?

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 Tilly's:

0.076 = US$29m ÷ (US$497m - US$109m) (Based on the trailing twelve months to May 2019.)

So, Tilly's has an ROCE of 7.6%.

View our latest analysis for Tilly's

Does Tilly's Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Tilly's's ROCE appears to be significantly below the 11% average in the Specialty Retail industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how Tilly's 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.

You can click on the image below to see (in greater detail) how Tilly's's past growth compares to other companies.

NYSE:TLYS Past Revenue and Net Income, July 25th 2019

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. 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 Tilly's's Current Liabilities Skew Its 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 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Tilly's has total assets of US$497m and current liabilities of US$109m. As a result, its current liabilities are equal to approximately 22% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.

The Bottom Line On Tilly's's ROCE

If Tilly's continues to earn an uninspiring ROCE, there may be better places to invest. 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.

I will like Tilly's 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.