Is Pizza Pizza Royalty Corp.'s (TSE:PZA) Capital Allocation Ability Worth Your Time?

Today we'll look at Pizza Pizza Royalty Corp. (TSE:PZA) and reflect on its potential as an investment. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.

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

ROCE measures the amount of pre-tax profits a company can generate from the 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. 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?

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 Pizza Pizza Royalty:

0.099 = CA$35m ÷ (CA$356m - CA$2.9m) (Based on the trailing twelve months to December 2018.)

So, Pizza Pizza Royalty has an ROCE of 9.9%.

See our latest analysis for Pizza Pizza Royalty

Is Pizza Pizza Royalty's ROCE Good?

One way to assess ROCE is to compare similar companies. We can see Pizza Pizza Royalty's ROCE is around the 9.9% average reported by the Hospitality industry. Setting aside the industry comparison for now, Pizza Pizza Royalty's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.

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. ROCE is only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our freereport on analyst forecasts for the company.

How Pizza Pizza Royalty's Current Liabilities Impact Its ROCE

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.

Pizza Pizza Royalty has total liabilities of CA$2.9m and total assets of CA$356m. Therefore its current liabilities are equivalent to approximately 0.8% of its total assets. Pizza Pizza Royalty has a low level of current liabilities, which have a minimal impact on its uninspiring ROCE.

What We Can Learn From Pizza Pizza Royalty's ROCE

Based on this information, Pizza Pizza Royalty appears to be a mediocre business. You might be able to find a better buy than Pizza Pizza Royalty. If you want a selection of possible winners, check out this freelist of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

If you like to buy stocks alongside management, then you might just love this freelist of companies. (Hint: insiders have been buying them).

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.

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. Thank you for reading.