Today we’ll evaluate Jack in the Box Inc. (NASDAQ:JACK) 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 of all, we’ll work out how to calculate ROCE. Next, we’ll compare it to others in its industry. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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’.
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 Jack in the Box:
0.31 = US$201m ÷ (US$829m – US$188m) (Based on the trailing twelve months to January 2019.)
Therefore, Jack in the Box has an ROCE of 31%.
Is Jack in the Box’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that Jack in the Box’s ROCE is meaningfully better than the 10% average in the Hospitality industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Putting aside its position relative to its industry for now, in absolute terms, Jack in the Box’s ROCE is currently very good.
As we can see, Jack in the Box currently has an ROCE of 31% compared to its ROCE 3 years ago, which was 20%. This makes us think the business might be improving.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Jack in the Box.
Do Jack in the Box’s Current Liabilities Skew 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Jack in the Box has total liabilities of US$188m and total assets of US$829m. Therefore its current liabilities are equivalent to approximately 23% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.
What We Can Learn From Jack in the Box’s ROCE
This is good to see, and with such a high ROCE, Jack in the Box may be worth a closer look. There might be better investments than Jack in the Box out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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If you spot an error that warrants correction, please contact the editor at email@example.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.