Today we are going to look at Ted Baker Plc (LON:TED) to see whether it might be an attractive investment prospect. 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 of all, we’ll work out how to calculate ROCE. Next, we’ll compare it to others in its industry. And finally, we’ll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. 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.
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 Ted Baker:
0.10 = UK£40m ÷ (UK£663m – UK£264m) (Based on the trailing twelve months to August 2019.)
Therefore, Ted Baker has an ROCE of 10%.
Is Ted Baker’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Ted Baker’s ROCE appears to be around the 8.9% average of the Luxury industry. Separate from Ted Baker’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Ted Baker’s current ROCE of 10% is lower than 3 years ago, when the company reported a 25% ROCE. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how Ted Baker’s past growth compares to other companies.
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 Ted Baker.
What Are Current Liabilities, And How Do They Affect Ted Baker’s ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Ted Baker has current liabilities of UK£264m and total assets of UK£663m. As a result, its current liabilities are equal to approximately 40% of its total assets. Ted Baker has a medium level of current liabilities, which would boost the ROCE.
The Bottom Line On Ted Baker’s ROCE
While its ROCE looks good, it’s worth remembering that the current liabilities are making the business look better. There might be better investments than Ted Baker out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
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 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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