Is Sleep Country Canada Holdings Inc.’s (TSE:ZZZ) 11% Return On Capital Employed Good News?

Today we’ll evaluate Sleep Country Canada Holdings Inc. (TSE:ZZZ) to determine whether it could have potential as an investment idea. 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 of all, we’ll work out how to calculate ROCE. Next, we’ll compare it to others in its industry. And finally, we’ll look at how its current liabilities are impacting its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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 Sleep Country Canada Holdings:

0.11 = CA$88m ÷ (CA$865m – CA$90m) (Based on the trailing twelve months to March 2019.)

So, Sleep Country Canada Holdings has an ROCE of 11%.

Check out our latest analysis for Sleep Country Canada Holdings

Does Sleep Country Canada Holdings Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, Sleep Country Canada Holdings’s ROCE appears to be around the 10% average of the Specialty Retail industry. Regardless of where Sleep Country Canada Holdings sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

Sleep Country Canada Holdings’s current ROCE of 11% is lower than its ROCE in the past, which was 16%, 3 years ago. This makes us wonder if the business is facing new challenges.

TSX:ZZZ Past Revenue and Net Income, July 29th 2019
TSX:ZZZ Past Revenue and Net Income, July 29th 2019

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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 Sleep Country Canada Holdings.

What Are Current Liabilities, And How Do They Affect Sleep Country Canada Holdings’s ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Sleep Country Canada Holdings has total liabilities of CA$90m and total assets of CA$865m. As a result, its current liabilities are equal to approximately 10% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.

The Bottom Line On Sleep Country Canada Holdings’s ROCE

This is good to see, and with a sound ROCE, Sleep Country Canada Holdings could be worth a closer look. There might be better investments than Sleep Country Canada Holdings out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.

I will like Sleep Country Canada Holdings better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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.