Is Stitch Fix, Inc.'s (NASDAQ:SFIX) Capital Allocation Ability Worth Your Time?

Today we'll look at Stitch Fix, Inc. (NASDAQ:SFIX) 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. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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?

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 Stitch Fix:

0.074 = US$30m ÷ (US$591m - US$189m) (Based on the trailing twelve months to April 2019.)

Therefore, Stitch Fix has an ROCE of 7.4%.

Check out our latest analysis for Stitch Fix

Is Stitch Fix's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Stitch Fix's ROCE appears to be around the 8.1% average of the Online Retail industry. Setting aside the industry comparison for now, Stitch Fix's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.

When considering this metric, keep in mind that it is backwards looking, and 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Do Stitch Fix's Current Liabilities Skew 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.

Stitch Fix has total assets of US$591m and current liabilities of US$189m. As a result, its current liabilities are equal to approximately 32% of its total assets. Stitch Fix's middling level of current liabilities have the effect of boosting its ROCE a bit.

The Bottom Line On Stitch Fix's ROCE

With this level of liabilities and a mediocre ROCE, there are potentially better investments out there. Of course, you might also be able to find a better stock than Stitch Fix. So you may wish to see this free collection of other companies that have grown earnings strongly.

I will like Stitch Fix better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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 editorial-team@simplywallst.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.