Today we'll look at Xcel Brands, Inc. (NASDAQ:XELB) 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. And finally, we'll look at how its current liabilities are impacting 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. 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'.
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 Xcel Brands:
0.018 = US$2.5m ÷ (US$151m - US$12m) (Based on the trailing twelve months to September 2019.)
So, Xcel Brands has an ROCE of 1.8%.
Is Xcel Brands's ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, Xcel Brands's ROCE appears to be significantly below the 11% average in the Specialty Retail industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Putting aside Xcel Brands's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. There are potentially more appealing investments elsewhere.
You can see in the image below how Xcel Brands's ROCE compares to its industry. Click to see more on past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. 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 Xcel Brands.
How Xcel Brands's Current Liabilities Impact 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Xcel Brands has total liabilities of US$12m and total assets of US$151m. Therefore its current liabilities are equivalent to approximately 8.1% of its total assets. Xcel Brands has a low level of current liabilities, which have a negligible impact on its already low ROCE.
What We Can Learn From Xcel Brands's ROCE
Nonetheless, there may be better places to invest your capital. You might be able to find a better investment than Xcel Brands. 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).
I will like Xcel Brands better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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.
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