Shareholders Should Look Hard At Pets at Home Group Plc’s (LON:PETS) 6.3%Return On Capital

Today we’ll evaluate Pets at Home Group Plc (LON:PETS) to determine whether it could have potential as an investment idea. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First up, we’ll look at what ROCE is and how we calculate it. Second, we’ll look at its ROCE compared to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.

Return On Capital Employed (ROCE): What is it?

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. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.

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 at Home Group:

0.063 = UK£95m ÷ (UK£1.8b – UK£285m) (Based on the trailing twelve months to October 2019.)

So, at Home Group has an ROCE of 6.3%.

Check out our latest analysis for at Home Group

Does at Home Group Have A Good ROCE?

One way to assess ROCE is to compare similar companies. We can see at Home Group’s ROCE is meaningfully below the Specialty Retail industry average of 9.3%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Setting aside the industry comparison for now, at Home Group’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.

at Home Group’s current ROCE of 6.3% is lower than 3 years ago, when the company reported a 9.3% ROCE. This makes us wonder if the business is facing new challenges. You can click on the image below to see (in greater detail) how at Home Group’s past growth compares to other companies.

LSE:PETS Past Revenue and Net Income, February 3rd 2020
LSE:PETS Past Revenue and Net Income, February 3rd 2020

Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately 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. ROCE is, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for at Home Group.

at Home Group’s Current Liabilities And Their Impact On 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

at Home Group has total assets of UK£1.8b and current liabilities of UK£285m. As a result, its current liabilities are equal to approximately 16% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.

The Bottom Line On at Home Group’s ROCE

With that in mind, we’re not overly impressed with at Home Group’s ROCE, so it may not be the most appealing prospect. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

I will like at Home Group 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.

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. Thank you for reading.