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Today we'll evaluate Ulta Beauty, Inc. (NASDAQ:ULTA) to determine whether it could have potential as an investment idea. 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 of all, we'll work out how to 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 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. 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 Ulta Beauty:
0.36 = US$854m ÷ (US$3.2b - US$824m) (Based on the trailing twelve months to February 2019.)
So, Ulta Beauty has an ROCE of 36%.
Does Ulta Beauty Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Ulta Beauty's ROCE is meaningfully better than the 13% average in the Specialty Retail 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. Regardless of the industry comparison, in absolute terms, Ulta Beauty's ROCE currently appears to be excellent.
In our analysis, Ulta Beauty's ROCE appears to be 36%, compared to 3 years ago, when its ROCE was 28%. This makes us think the business might be improving.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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 Ulta Beauty's Current Liabilities Skew Its ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Ulta Beauty has total assets of US$3.2b and current liabilities of US$824m. Therefore its current liabilities are equivalent to approximately 26% of its total assets. The fairly low level of current liabilities won't have much impact on the already great ROCE.
What We Can Learn From Ulta Beauty's ROCE
This is good to see, and with such a high ROCE, Ulta Beauty may be worth a closer look. But note: Ulta Beauty 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).
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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 firstname.lastname@example.org. 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.