Today we'll look at Willamette Valley Vineyards, Inc. (NASDAQ:WVVI) and reflect on its potential as an investment. 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. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Understanding Return On Capital Employed (ROCE)
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. 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 Willamette Valley Vineyards:
0.06 = US$3.7m ÷ (US$65m - US$3.9m) (Based on the trailing twelve months to June 2019.)
Therefore, Willamette Valley Vineyards has an ROCE of 6.0%.
Does Willamette Valley Vineyards Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, Willamette Valley Vineyards's ROCE appears meaningfully below the 10% average reported by the Beverage industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Separate from how Willamette Valley Vineyards 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.
We can see that , Willamette Valley Vineyards currently has an ROCE of 6.0%, less than the 9.0% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds. You can see in the image below how Willamette Valley Vineyards's ROCE compares to its industry. Click to see more on past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. How cyclical is Willamette Valley Vineyards? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Do Willamette Valley Vineyards'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.
Willamette Valley Vineyards has total liabilities of US$3.9m and total assets of US$65m. As a result, its current liabilities are equal to approximately 6.0% of its total assets. Willamette Valley Vineyards has a low level of current liabilities, which have a minimal impact on its uninspiring ROCE.
What We Can Learn From Willamette Valley Vineyards's ROCE
Based on this information, Willamette Valley Vineyards appears to be a mediocre business. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.