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Today we are going to look at Farmmi, Inc. (NASDAQ:FAMI) to see whether it might be an attractive investment prospect. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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 Farmmi:
0.16 = US$3.1m ÷ (US$22m – US$2.2m) (Based on the trailing twelve months to September 2018.)
So, Farmmi has an ROCE of 16%.
Does Farmmi Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Farmmi’s ROCE is meaningfully higher than the 8.7% average in the Food industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Farmmi compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Farmmi’s current ROCE of 16% is lower than its ROCE in the past, which was 59%, 3 years ago. This makes us wonder if the business is facing new challenges.
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, after all, simply a snap shot of a single year. How cyclical is Farmmi? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Do Farmmi’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. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Farmmi has total liabilities of US$2.2m and total assets of US$22m. Therefore its current liabilities are equivalent to approximately 10% of its total assets. Low current liabilities are not boosting the ROCE too much.
The Bottom Line On Farmmi’s ROCE
This is good to see, and with a sound ROCE, Farmmi could be worth a closer look. Of course you might be able to find a better stock than Farmmi. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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 firstname.lastname@example.org.