Today we are going to look at Rocky Mountain Dealerships Inc. (TSE:RME) to see whether it might be an attractive investment prospect. 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. 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.
Understanding 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. 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 Rocky Mountain Dealerships:
0.18 = CA$42m ÷ (CA$694m – CA$457m) (Based on the trailing twelve months to December 2018.)
Therefore, Rocky Mountain Dealerships has an ROCE of 18%.
Does Rocky Mountain Dealerships Have A Good ROCE?
One way to assess ROCE is to compare similar companies. We can see Rocky Mountain Dealerships’s ROCE is around the 16% average reported by the Trade Distributors industry. Independently of how Rocky Mountain Dealerships compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Rocky Mountain Dealerships.
Rocky Mountain Dealerships’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.
Rocky Mountain Dealerships has total assets of CA$694m and current liabilities of CA$457m. Therefore its current liabilities are equivalent to approximately 66% of its total assets. Rocky Mountain Dealerships has a relatively high level of current liabilities, boosting its ROCE meaningfully.
Our Take On Rocky Mountain Dealerships’s ROCE
While its ROCE looks decent, it wouldn’t look so good if it reduced current liabilities. Rocky Mountain Dealerships looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
I will like Rocky Mountain Dealerships 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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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. Thank you for reading.