Today we’ll evaluate Sturm, Ruger & Company, Inc. (NYSE:RGR) to determine whether it could have potential as an investment idea. 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.
First, 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.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its 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. 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 Sturm Ruger:
0.14 = US$39m ÷ (US$349m – US$61m) (Based on the trailing twelve months to December 2019.)
So, Sturm Ruger has an ROCE of 14%.
Is Sturm Ruger’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Sturm Ruger’s ROCE appears to be around the 16% average of the Leisure industry. Separate from Sturm Ruger’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
We can see that, Sturm Ruger currently has an ROCE of 14%, less than the 51% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds. The image below shows how Sturm Ruger’s ROCE compares to its industry, and you can click it to see more detail on its past growth.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. If Sturm Ruger is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Do Sturm Ruger’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 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Sturm Ruger has current liabilities of US$61m and total assets of US$349m. As a result, its current liabilities are equal to approximately 18% of its total assets. Low current liabilities are not boosting the ROCE too much.
Our Take On Sturm Ruger’s ROCE
With that in mind, Sturm Ruger’s ROCE appears pretty good. There might be better investments than Sturm Ruger 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 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.
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