Today we are going to look at Citi Trends, Inc. (NASDAQ:CTRN) to see whether it might be an attractive investment prospect. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
Firstly, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. All else being equal, a better business will have a higher ROCE. 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?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
Or for Citi Trends:
0.053 = US$16m ÷ (US$448m – US$140m) (Based on the trailing twelve months to August 2019.)
So, Citi Trends has an ROCE of 5.3%.
Does Citi Trends Have A Good ROCE?
One way to assess ROCE is to compare similar companies. We can see Citi Trends’s ROCE is meaningfully below the Specialty Retail industry average of 10%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Putting aside Citi Trends’s performance relative to its industry, its ROCE in absolute terms is poor – considering the risk of owning stocks compared to government bonds. It is likely that there are more attractive prospects out there.
Citi Trends’s current ROCE of 5.3% is lower than its ROCE in the past, which was 8.7%, 3 years ago. Therefore we wonder if the company is facing new headwinds. The image below shows how Citi Trends’s ROCE compares to its industry, and you can click it to see more detail on its 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. ROCE is only a point-in-time measure. You can check if Citi Trends has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Citi Trends’s ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Citi Trends has total liabilities of US$140m and total assets of US$448m. Therefore its current liabilities are equivalent to approximately 31% of its total assets. In light of sufficient current liabilities to noticeably boost the ROCE, Citi Trends’s ROCE is concerning.
The Bottom Line On Citi Trends’s ROCE
This company may not be the most attractive investment prospect. You might be able to find a better investment than Citi Trends. 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).
Citi Trends is not the only stock that insiders are buying. 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 email@example.com. 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.