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Today we’ll look at Texas Roadhouse, Inc. (NASDAQ:TXRH) and reflect on its potential as an investment. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Then we’ll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. 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?
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 Texas Roadhouse:
0.12 = US$185m ÷ (US$1.9b – US$362m) (Based on the trailing twelve months to March 2019.)
So, Texas Roadhouse has an ROCE of 12%.
Does Texas Roadhouse Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Texas Roadhouse’s ROCE is meaningfully higher than the 9.4% average in the Hospitality industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from Texas Roadhouse’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Texas Roadhouse’s current ROCE of 12% is lower than 3 years ago, when the company reported a 19% ROCE. Therefore we wonder if the company is facing new headwinds.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Texas Roadhouse.
What Are Current Liabilities, And How Do They Affect Texas Roadhouse’s ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Texas Roadhouse has total liabilities of US$362m and total assets of US$1.9b. As a result, its current liabilities are equal to approximately 19% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
Our Take On Texas Roadhouse’s ROCE
This is good to see, and with a sound ROCE, Texas Roadhouse could be worth a closer look. Texas Roadhouse 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.
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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.