Ruth’s Hospitality Group Inc (NASDAQ:RUTH): Why Return On Capital Employed Is Important

This analysis is intended to introduce important early concepts to people who are starting to invest and looking to gauge the potential return on investment in Ruth’s Hospitality Group Inc (NASDAQ:RUTH).

Purchasing Ruth’s Hospitality Group gives you an ownership stake in the company. Your equity share is granted in return for the capital provided to the business to operate, and in order for an investment to be successful the business has to create earnings from the funds that make up this capital. You need to pay attention to this because your return on investment is linked to dividends and internal investments to improve the business, which can only occur if the company is expected to produce adequate earnings with the capital that has been provided. Thus, to understand how your money can grow by investing in Ruth’s Hospitality Group, you need to look at what the company returns to owners for the use of their capital, which can be done in many ways but today we will use return on capital employed (ROCE).

Check out our latest analysis for Ruth’s Hospitality Group

Ruth’s Hospitality Group’s Return On Capital Employed

When you choose to invest in a company, there is an opportunity cost because that money could’ve been invested elsewhere. The cost of missing out on another opportunity comes in the form of the potential long term gain you could’ve received, which is dependent on the gap between the return on capital you could’ve achieved and that of the company you invested in. Hence, capital returns are very important, and should be examined before you invest in conjunction with a certain benchmark that represents the minimum return you require to be compensated for the risk of missing out on other potentially lucrative investments. A good metric to use is return on capital employed (ROCE), which helps us gauge how much income can be created from the funds needed to operate the business. This metric will tell us if Ruth’s Hospitality Group is good at growing investor capital. Take a look at the formula box beneath:

ROCE Calculation for RUTH

Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)

Capital Employed = (Total Assets – Current Liabilities)

∴ ROCE = US$53m ÷ (US$240m – US$69m) = 32%

The calculation above shows that RUTH’s earnings were 32% of capital employed. This makes Ruth’s Hospitality Group exceptionally profitable when compared to a robust 15% ROCE yardstick. So if this rate continues in to the future and is able to either provide solid dividends or reinvestment opportunities, your capital will enlarge at a rapid rate over time.

NasdaqGS:RUTH Last Perf November 27th 18
NasdaqGS:RUTH Last Perf November 27th 18

A deeper look

RUTH is efficient with the use of capital, but this is only the case if RUTH continues to maintain the presently healthy ROCE, which will change if the company either earns less or requires more capital to create earnings. So it is important for investors to understand what is going on under the hood and look at how these variables have been behaving. If you go back three years, you’ll find that RUTH’s ROCE has decreased from 34%. Conversely, the movement in the earnings variable shows a jump from US$39m to US$53m albeit capital employed has grown by a relatively larger volume because of a rise in total assets and decrease in current liabilities (less borrowed money) , indicating that the previous growth in earnings has not been able to improve ROCE because the company now needs to employ more capital to operate the business.

Next Steps

ROCE for RUTH investors has declined in the last few years, however, the company still remains an attractive candidate that is capable of producing solid capital returns and a potentially strong return on investment. Before making any decisions, ROCE does not tell the whole picture so you need to pay attention to other fundamentals like future prospects and valuation. Without considering these fundamentals, you cannot be sure if the downward path is a signal to run, or just a blip in an otherwise solid return profile. If you’re interested in diving deeper, take a look at what I’ve linked below for further information on these fundamentals and other potential investment opportunities.

  1. Future Outlook: What are well-informed industry analysts predicting for RUTH’s future growth? Take a look at our free research report of analyst consensus for RUTH’s outlook.
  2. Valuation: What is RUTH worth today? Is the stock undervalued, even if its ROCE is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether RUTH is currently mispriced by the market.
  3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

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 editorial-team@simplywallst.com.