Today we'll look at Tractor Supply Company (NASDAQ:TSCO) 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 up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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 Tractor Supply:
0.17 = US$730m ÷ (US$5.4b - US$1.3b) (Based on the trailing twelve months to September 2019.)
So, Tractor Supply has an ROCE of 17%.
Is Tractor Supply's ROCE Good?
One way to assess ROCE is to compare similar companies. Tractor Supply's ROCE appears to be substantially greater than the 11% average in the Specialty Retail industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from Tractor Supply's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Tractor Supply's current ROCE of 17% is lower than 3 years ago, when the company reported a 35% ROCE. So investors might consider if it has had issues recently. The image below shows how Tractor Supply's ROCE compares to its industry, and you can click it to see more detail on its past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Tractor Supply.
Do Tractor Supply'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. 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.
Tractor Supply has total assets of US$5.4b and current liabilities of US$1.3b. As a result, its current liabilities are equal to approximately 23% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
The Bottom Line On Tractor Supply's ROCE
Overall, Tractor Supply has a decent ROCE and could be worthy of further research. Tractor Supply shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
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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