Penn National Gaming, Inc. (NASDAQ:PENN) Might Not Be A Great Investment

Today we are going to look at Penn National Gaming, Inc. (NASDAQ:PENN) 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. Last but not least, we'll look at what impact its current liabilities have on 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'.

How Do You Calculate Return On Capital Employed?

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 Penn National Gaming:

0.061 = US$819m ÷ (US$14b - US$877m) (Based on the trailing twelve months to September 2019.)

So, Penn National Gaming has an ROCE of 6.1%.

View our latest analysis for Penn National Gaming

Is Penn National Gaming's ROCE Good?

One way to assess ROCE is to compare similar companies. In this analysis, Penn National Gaming's ROCE appears meaningfully below the 8.5% average reported by the Hospitality industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Separate from how Penn National Gaming stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.

Penn National Gaming's current ROCE of 6.1% is lower than its ROCE in the past, which was 12%, 3 years ago. So investors might consider if it has had issues recently. You can see in the image below how Penn National Gaming's ROCE compares to its industry. Click to see more on past growth.

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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Penn National Gaming.

How Penn National Gaming's Current Liabilities Impact Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Penn National Gaming has total liabilities of US$877m and total assets of US$14b. Therefore its current liabilities are equivalent to approximately 6.1% of its total assets. Penn National Gaming has a low level of current liabilities, which have a minimal impact on its uninspiring ROCE.

What We Can Learn From Penn National Gaming's ROCE

Based on this information, Penn National Gaming appears to be a mediocre business. Of course, you might also be able to find a better stock than Penn National Gaming. So you may wish to see this free collection of other companies that have grown earnings strongly.

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

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.

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