Today we are going to look at Crown Crafts, Inc. (NASDAQ:CRWS) to see whether it might be an attractive investment prospect. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared 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. In general, businesses with a higher ROCE are usually better quality. 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 Crown Crafts:
0.16 = US$7.4m ÷ (US$55m – US$7.7m) (Based on the trailing twelve months to March 2019.)
Therefore, Crown Crafts has an ROCE of 16%.
Does Crown Crafts Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Crown Crafts’s ROCE is meaningfully higher than the 13% average in the Luxury industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of where Crown Crafts sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Crown Crafts’s current ROCE of 16% is lower than 3 years ago, when the company reported a 28% ROCE. So investors might consider if it has had issues recently.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Crown Crafts.
Do Crown Crafts’s Current Liabilities Skew 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 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.
Crown Crafts has total assets of US$55m and current liabilities of US$7.7m. As a result, its current liabilities are equal to approximately 14% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
What We Can Learn From Crown Crafts’s ROCE
This is good to see, and with a sound ROCE, Crown Crafts could be worth a closer look. There might be better investments than Crown Crafts 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.
I will like Crown Crafts better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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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.