Today we’ll evaluate Big 5 Sporting Goods Corporation (NASDAQ:BGFV) 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. And finally, we’ll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. 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?
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 Big 5 Sporting Goods:
0.033 = US$15m ÷ (US$689m – US$223m) (Based on the trailing twelve months to December 2019.)
So, Big 5 Sporting Goods has an ROCE of 3.3%.
Does Big 5 Sporting Goods Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. We can see Big 5 Sporting Goods’s ROCE is meaningfully below the Specialty Retail industry average of 9.7%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Putting aside Big 5 Sporting Goods’s performance relative to its industry, its ROCE in absolute terms is poor – considering the risk of owning stocks compared to government bonds. It is likely that there are more attractive prospects out there.
We can see that, Big 5 Sporting Goods currently has an ROCE of 3.3%, less than the 12% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how Big 5 Sporting Goods’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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is Big 5 Sporting Goods? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Do Big 5 Sporting Goods’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 counter this, investors can check if a company has high current liabilities relative to total assets.
Big 5 Sporting Goods has total assets of US$689m and current liabilities of US$223m. As a result, its current liabilities are equal to approximately 32% of its total assets. In light of sufficient current liabilities to noticeably boost the ROCE, Big 5 Sporting Goods’s ROCE is concerning.
What We Can Learn From Big 5 Sporting Goods’s ROCE
There are likely better investments out there. Of course, you might also be able to find a better stock than Big 5 Sporting Goods. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like Big 5 Sporting Goods 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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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.