Today we'll look at Dollarama Inc. (TSE:DOL) and reflect on its potential as an investment. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its 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 Dollarama:
0.28 = CA$822m ÷ (CA$3.7b - CA$803m) (Based on the trailing twelve months to November 2019.)
Therefore, Dollarama has an ROCE of 28%.
Does Dollarama Have A Good ROCE?
One way to assess ROCE is to compare similar companies. In our analysis, Dollarama's ROCE is meaningfully higher than the 10% average in the Multiline Retail industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of the industry comparison, in absolute terms, Dollarama's ROCE currently appears to be excellent.
Dollarama's current ROCE of 28% is lower than 3 years ago, when the company reported a 44% ROCE. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how Dollarama's past growth compares to other companies.
When considering this metric, keep in mind that it is backwards looking, and 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. 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 Dollarama.
Dollarama's Current Liabilities And Their Impact On Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Dollarama has total assets of CA$3.7b and current liabilities of CA$803m. As a result, its current liabilities are equal to approximately 22% of its total assets. The fairly low level of current liabilities won't have much impact on the already great ROCE.
Our Take On Dollarama's ROCE
, Dollarama shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.
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