Are J D Wetherspoon plc’s (LON:JDW) High Returns Really That Great?

Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!

Today we are going to look at J D Wetherspoon plc (LON:JDW) to see whether it might be an attractive investment prospect. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First of all, we’ll work out how to calculate ROCE. Next, we’ll compare it to others in its industry. Finally, we’ll look at how its current liabilities affect its ROCE.

What is 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. All else being equal, a better business will have a higher ROCE. 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’.

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 J D Wetherspoon:

0.11 = UK£122m ÷ (UK£1.5b – UK£340m) (Based on the trailing twelve months to January 2019.)

So, J D Wetherspoon has an ROCE of 11%.

See our latest analysis for J D Wetherspoon

Does J D Wetherspoon Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. J D Wetherspoon’s ROCE appears to be substantially greater than the 8.3% average in the Hospitality industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how J D Wetherspoon compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

LSE:JDW Past Revenue and Net Income, June 18th 2019
LSE:JDW Past Revenue and Net Income, June 18th 2019

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. Since the future is so important for investors, you should check out our free report on analyst forecasts for J D Wetherspoon.

What Are Current Liabilities, And How Do They Affect J D Wetherspoon’s 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 the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

J D Wetherspoon has total liabilities of UK£340m and total assets of UK£1.5b. As a result, its current liabilities are equal to approximately 23% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.

What We Can Learn From J D Wetherspoon’s ROCE

This is good to see, and with a sound ROCE, J D Wetherspoon could be worth a closer look. J D Wetherspoon 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.

If you are like me, then you will not want to miss this free list of growing companies that insiders are 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.