Today we’ll evaluate Izu Shaboten Resort Co.,Ltd (TYO:6819) to determine whether it could have potential as an investment idea. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the 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 is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the 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?
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 Izu Shaboten ResortLtd:
0.13 = JP¥343m ÷ (JP¥2.9b – JP¥287m) (Based on the trailing twelve months to December 2019.)
So, Izu Shaboten ResortLtd has an ROCE of 13%.
Does Izu Shaboten ResortLtd Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Izu Shaboten ResortLtd’s ROCE appears to be substantially greater than the 9.3% average in the Hospitality industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from Izu Shaboten ResortLtd’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Izu Shaboten ResortLtd’s current ROCE of 13% is lower than its ROCE in the past, which was 23%, 3 years ago. This makes us wonder if the business is facing new challenges. You can click on the image below to see (in greater detail) how Izu Shaboten ResortLtd’s past growth compares to other companies.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is Izu Shaboten ResortLtd? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Do Izu Shaboten ResortLtd’s Current Liabilities Skew Its ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Izu Shaboten ResortLtd has total assets of JP¥2.9b and current liabilities of JP¥287m. As a result, its current liabilities are equal to approximately 9.9% of its total assets. Low current liabilities have only a minimal impact on Izu Shaboten ResortLtd’s ROCE, making its decent returns more credible.
Our Take On Izu Shaboten ResortLtd’s ROCE
This is good to see, and while better prospects may exist, Izu Shaboten ResortLtd seems worth researching further. Izu Shaboten ResortLtd 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.
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