Why Stitch Fix, Inc.’s (NASDAQ:SFIX) Use Of Investor Capital Doesn’t Look Great

Today we’ll evaluate Stitch Fix, Inc. (NASDAQ:SFIX) to determine whether it could have potential as an investment idea. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.

First, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. 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 is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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’.

So, How Do We Calculate ROCE?

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 Stitch Fix:

0.023 = US$13m ÷ (US$797m – US$243m) (Based on the trailing twelve months to November 2019.)

Therefore, Stitch Fix has an ROCE of 2.3%.

See our latest analysis for Stitch Fix

Does Stitch Fix Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. We can see Stitch Fix’s ROCE is meaningfully below the Online Retail industry average of 6.2%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Regardless of how Stitch Fix stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). It is likely that there are more attractive prospects out there.

We can see that, Stitch Fix currently has an ROCE of 2.3%, less than the 59% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how Stitch Fix’s past growth compares to other companies.

NasdaqGS:SFIX Past Revenue and Net Income, March 3rd 2020
NasdaqGS:SFIX Past Revenue and Net Income, March 3rd 2020

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the 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 Stitch Fix.

What Are Current Liabilities, And How Do They Affect Stitch Fix’s ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Stitch Fix has current liabilities of US$243m and total assets of US$797m. Therefore its current liabilities are equivalent to approximately 30% of its total assets. With a medium level of current liabilities boosting the ROCE a little, Stitch Fix’s low ROCE is unappealing.

Our Take On Stitch Fix’s ROCE

So researching other companies may be a better use of your time. Of course, you might also be able to find a better stock than Stitch Fix. So you may wish to see this free collection of other companies that have grown earnings strongly.

I will like Stitch Fix better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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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