Today we’ll look at Starbucks Corporation (NASDAQ:SBUX) and reflect on its potential as an investment. 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, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. 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. Generally speaking a higher ROCE is better. In the end, ROCE 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.’
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 Starbucks:
0.21 = US$3.8b ÷ (US$24b – US$5.7b) (Based on the trailing twelve months to September 2018.)
Therefore, Starbucks has an ROCE of 21%.
Check out our latest analysis for Starbucks
Does Starbucks Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Starbucks’s ROCE is meaningfully better than the 10% average in the Hospitality industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Regardless of where Starbucks sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Starbucks’s current ROCE of 21% is lower than its ROCE in the past, which was 38%, 3 years ago. So investors might consider if it has had issues recently.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for Starbucks.
Do Starbucks’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) unfairly boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Starbucks has total liabilities of US$5.7b and total assets of US$24b. Therefore its current liabilities are equivalent to approximately 24% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
What We Can Learn From Starbucks’s ROCE
This is good to see, and with a sound ROCE, Starbucks could be worth a closer look. While the ROCE is useful information, it is not always predictive. We need to do more work before making a decision. One data point to check is if insiders have bought shares recently.
Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of interesting companies.
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.