What Can We Make Of Sprouts Farmers Market, Inc.’s (NASDAQ:SFM) High Return On Capital?

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Today we are going to look at Sprouts Farmers Market, Inc. (NASDAQ:SFM) 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. Next, we’ll compare it to others in its industry. Finally, we’ll look at how its current liabilities affect its ROCE.

Return On Capital Employed (ROCE): What is it?

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’.

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 Sprouts Farmers Market:

0.17 = US$227m ÷ (US$1.7b – US$297m) (Based on the trailing twelve months to September 2018.)

So, Sprouts Farmers Market has an ROCE of 17%.

Check out our latest analysis for Sprouts Farmers Market

Does Sprouts Farmers Market Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Sprouts Farmers Market’s ROCE is meaningfully higher than the 9.5% average in the Consumer Retailing industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Regardless of where Sprouts Farmers Market sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

NasdaqGS:SFM Past Revenue and Net Income, February 21st 2019
NasdaqGS:SFM Past Revenue and Net Income, February 21st 2019

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. 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 Sprouts Farmers Market.

Sprouts Farmers Market’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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Sprouts Farmers Market has total assets of US$1.7b and current liabilities of US$297m. As a result, its current liabilities are equal to approximately 18% of its total assets. Low current liabilities are not boosting the ROCE too much.

Our Take On Sprouts Farmers Market’s ROCE

Overall, Sprouts Farmers Market has a decent ROCE and could be worthy of further research. But note: Sprouts Farmers Market 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 Sprouts Farmers Market 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.