Today we are going to look at Crown Crafts, Inc. (NASDAQ:CRWS) to see whether it might be an attractive investment prospect. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
Firstly, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.
What is 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. 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?
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 Crown Crafts:
0.19 = US$8.2m ÷ (US$55m – US$11m) (Based on the trailing twelve months to December 2018.)
Therefore, Crown Crafts has an ROCE of 19%.
Is Crown Crafts’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Crown Crafts’s ROCE appears to be substantially greater than the 14% average in the Luxury industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from Crown Crafts’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
As we can see, Crown Crafts currently has an ROCE of 19%, less than the 27% it reported 3 years ago. This makes us wonder if the business is facing new challenges.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for Crown Crafts.
What Are Current Liabilities, And How Do They Affect Crown Crafts’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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Crown Crafts has total assets of US$55m and current liabilities of US$11m. As a result, its current liabilities are equal to approximately 20% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
What We Can Learn From Crown Crafts’s ROCE
With that in mind, Crown Crafts’s ROCE appears pretty good. Crown Crafts 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.
I will like Crown Crafts 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 firstname.lastname@example.org. 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.