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Today we are going to look at Reitmans (Canada) Limited (TSE:RET.A) to see whether it might be an attractive investment prospect. 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. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. 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’.
How Do You Calculate Return On Capital Employed?
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 Reitmans (Canada):
0.033 = -CA$1.3m ÷ (CA$519m – CA$129m) (Based on the trailing twelve months to November 2018.)
So, Reitmans (Canada) has an ROCE of 3.3%.
Is Reitmans (Canada)’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, Reitmans (Canada)’s ROCE appears meaningfully below the 9.7% average reported by the Specialty Retail industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Independently of how Reitmans (Canada) compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.9% available in government bonds. Readers may wish to look for more rewarding investments.
Reitmans (Canada) has an ROCE of 3.3%, but it didn’t have an ROCE 3 years ago, since it was unprofitable. That implies the business has been improving.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. You can check if Reitmans (Canada) has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Reitmans (Canada)’s Current Liabilities And Their Impact On 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.
Reitmans (Canada) has total liabilities of CA$129m and total assets of CA$519m. As a result, its current liabilities are equal to approximately 25% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.
Our Take On Reitmans (Canada)’s ROCE
Reitmans (Canada) has a poor ROCE, and there may be better investment prospects out there. But note: Reitmans (Canada) may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
I will like Reitmans (Canada) better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.