Today we’ll look at Williams-Sonoma, Inc. (NYSE:WSM) and reflect on its potential as an investment. 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, 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.
Return On Capital Employed (ROCE): What is it?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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’.
So, How Do We Calculate ROCE?
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 Williams-Sonoma:
0.27 = US$466m ÷ (US$2.7b – US$1.0b) (Based on the trailing twelve months to October 2018.)
Therefore, Williams-Sonoma has an ROCE of 27%.
Does Williams-Sonoma Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Williams-Sonoma’s ROCE is meaningfully better than the 13% 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. Setting aside the comparison to its industry for a moment, Williams-Sonoma’s ROCE in absolute terms currently looks quite high.
Williams-Sonoma’s current ROCE of 27% is lower than 3 years ago, when the company reported a 37% ROCE. Therefore we wonder if the company is facing new headwinds.
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 only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Williams-Sonoma.
Williams-Sonoma’s Current Liabilities And Their Impact On 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 the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counter this, investors can check if a company has high current liabilities relative to total assets.
Williams-Sonoma has total assets of US$2.7b and current liabilities of US$1.0b. Therefore its current liabilities are equivalent to approximately 38% of its total assets. A medium level of current liabilities boosts Williams-Sonoma’s ROCE somewhat.
What We Can Learn From Williams-Sonoma’s ROCE
Despite this, it reports a high ROCE, and may be worth investigating further. You might be able to find a better buy than Williams-Sonoma. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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.