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Today we’ll look at America’s Car-Mart, Inc. (NASDAQ:CRMT) 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 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.
Understanding Return On Capital Employed (ROCE)
ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. 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 America’s Car-Mart:
0.15 = US$68m ÷ (US$493m – US$33m) (Based on the trailing twelve months to April 2019.)
So, America’s Car-Mart has an ROCE of 15%.
Does America’s Car-Mart Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, America’s Car-Mart’s ROCE is meaningfully higher than the 11% average in the Specialty Retail industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from America’s Car-Mart’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
In our analysis, America’s Car-Mart’s ROCE appears to be 15%, compared to 3 years ago, when its ROCE was 5.8%. This makes us think about whether the company has been reinvesting shrewdly.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. 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 America’s Car-Mart.
What Are Current Liabilities, And How Do They Affect America’s Car-Mart’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.
America’s Car-Mart has total liabilities of US$33m and total assets of US$493m. Therefore its current liabilities are equivalent to approximately 6.7% of its total assets. Low current liabilities have only a minimal impact on America’s Car-Mart’s ROCE, making its decent returns more credible.
Our Take On America’s Car-Mart’s ROCE
If it is able to keep this up, America’s Car-Mart could be attractive. There might be better investments than America’s Car-Mart out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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 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. Thank you for reading.