Today we’ll evaluate Nordstrom, Inc. (NYSE:JWN) to determine whether it could have potential as an investment idea. 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.
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. Ultimately, it is a useful but imperfect metric. 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?
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 Nordstrom:
0.13 = US$818m ÷ (US$10b – US$4.0b) (Based on the trailing twelve months to November 2019.)
So, Nordstrom has an ROCE of 13%.
Is Nordstrom’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, Nordstrom’s ROCE appears to be around the 12% average of the Multiline Retail industry. Regardless of where Nordstrom sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Nordstrom’s current ROCE of 13% is lower than 3 years ago, when the company reported a 20% ROCE. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how Nordstrom’s past growth compares to other companies.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Nordstrom.
Nordstrom’s Current Liabilities And Their Impact On 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. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Nordstrom has total assets of US$10b and current liabilities of US$4.0b. As a result, its current liabilities are equal to approximately 40% of its total assets. Nordstrom has a medium level of current liabilities, which would boost the ROCE.
Our Take On Nordstrom’s ROCE
Nordstrom’s ROCE does look good, but the level of current liabilities also contribute to that. Nordstrom looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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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