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. And finally, we’ll look at how its current liabilities are impacting 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. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.
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 Ruth’s Hospitality Group:
0.14 = US$55m ÷ (US$471m – US$87m) (Based on the trailing twelve months to September 2019.)
So, Ruth’s Hospitality Group has an ROCE of 14%.
Is Ruth’s Hospitality Group’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Ruth’s Hospitality Group’s ROCE appears to be substantially greater than the 8.5% average in the Hospitality industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how Ruth’s Hospitality Group compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Ruth’s Hospitality Group’s current ROCE of 14% is lower than its ROCE in the past, which was 45%, 3 years ago. This makes us wonder if the business is facing new challenges. The image below shows how Ruth’s Hospitality Group’s ROCE compares to its industry, and you can click it to see more detail on its past growth.
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 only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect Ruth’s Hospitality Group’s 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Ruth’s Hospitality Group has total assets of US$471m and current liabilities of US$87m. Therefore its current liabilities are equivalent to approximately 19% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
What We Can Learn From Ruth’s Hospitality Group’s ROCE
This is good to see, and with a sound ROCE, Ruth’s Hospitality Group could be worth a closer look. Ruth’s Hospitality Group 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.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.
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