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Today we’ll evaluate Chuy’s Holdings, Inc. (NASDAQ:CHUY) to determine whether it could have potential as an investment idea. 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 of all, we’ll work out how to calculate ROCE. Next, we’ll compare it to others in its industry. Then we’ll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
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. Overall, it is a valuable metric that has its flaws. 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 Chuy’s Holdings:
0.073 = US$22m ÷ (US$275m – US$25m) (Based on the trailing twelve months to September 2018.)
So, Chuy’s Holdings has an ROCE of 7.3%.
Does Chuy’s Holdings Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. We can see Chuy’s Holdings’s ROCE is meaningfully below the Hospitality industry average of 9.7%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Separate from how Chuy’s Holdings stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.
Chuy’s Holdings’s current ROCE of 7.3% is lower than its ROCE in the past, which was 13%, 3 years ago. Therefore we wonder if the company is facing new headwinds.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Chuy’s Holdings.
What Are Current Liabilities, And How Do They Affect Chuy’s Holdings’s 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Chuy’s Holdings has total liabilities of US$25m and total assets of US$275m. As a result, its current liabilities are equal to approximately 9.2% of its total assets. Chuy’s Holdings reports few current liabilities, which have a negligible impact on its unremarkable ROCE.
What We Can Learn From Chuy’s Holdings’s ROCE
If performance improves, then Chuy’s Holdings may be an OK investment, especially at the right valuation. But note: Chuy’s Holdings 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).
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.