Today we’ll look at Ruth’s Hospitality Group, Inc. (NASDAQ:RUTH) and reflect on its potential as an investment. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
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.
Understanding Return On Capital Employed (ROCE)
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its 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 Ruth’s Hospitality Group:
0.33 = US$53m ÷ (US$255m – US$95m) (Based on the trailing twelve months to December 2018.)
Therefore, Ruth’s Hospitality Group has an ROCE of 33%.
Is Ruth’s Hospitality Group’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Ruth’s Hospitality Group’s ROCE is meaningfully better than the 9.9% average in the Hospitality industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Setting aside the comparison to its industry for a moment, Ruth’s Hospitality Group’s ROCE in absolute terms currently looks quite high.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. 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 Ruth’s Hospitality Group.
Do Ruth’s Hospitality Group’s Current Liabilities Skew Its ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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.
Ruth’s Hospitality Group has total assets of US$255m and current liabilities of US$95m. As a result, its current liabilities are equal to approximately 37% of its total assets. Ruth’s Hospitality Group has a medium level of current liabilities, boosting its ROCE somewhat.
What We Can Learn From Ruth’s Hospitality Group’s ROCE
Even so, it has a great ROCE, and could be an attractive prospect for further research. But note: Ruth’s Hospitality Group 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.
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.