Today we’ll look at Amazon.com, Inc. (NASDAQ:AMZN) and reflect on its potential as an investment. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First of all, we’ll work out how to 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.
What is Return On Capital Employed (ROCE)?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. 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 Amazon.com:
0.10 = US$14b ÷ (US$225b – US$88b) (Based on the trailing twelve months to December 2019.)
So, Amazon.com has an ROCE of 10%.
Does Amazon.com Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Amazon.com’s ROCE is meaningfully higher than the 7.7% average in the Online Retail industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of where Amazon.com sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
You can click on the image below to see (in greater detail) how Amazon.com’s past growth compares to other companies.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for Amazon.com.
What Are Current Liabilities, And How Do They Affect Amazon.com’s ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Amazon.com has current liabilities of US$88b and total assets of US$225b. As a result, its current liabilities are equal to approximately 39% of its total assets. With this level of current liabilities, Amazon.com’s ROCE is boosted somewhat.
What We Can Learn From Amazon.com’s ROCE
While its ROCE looks good, it’s worth remembering that the current liabilities are making the business look better. Amazon.com 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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