Today we’ll evaluate Tractor Supply Company (NASDAQ:TSCO) to determine whether it could have potential as an investment idea. 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. Then we’ll determine how its current liabilities are affecting 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. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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 Tractor Supply:
0.17 = US$730m ÷ (US$5.4b – US$1.3b) (Based on the trailing twelve months to September 2019.)
Therefore, Tractor Supply has an ROCE of 17%.
Does Tractor Supply Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Tractor Supply’s ROCE is meaningfully better 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 Tractor Supply’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Tractor Supply’s current ROCE of 17% is lower than its ROCE in the past, which was 35%, 3 years ago. This makes us wonder if the business is facing new challenges. You can click on the image below to see (in greater detail) how Tractor Supply’s past growth compares to other companies.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. 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 Tractor Supply.
How Tractor Supply’s Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Tractor Supply has total assets of US$5.4b and current liabilities of US$1.3b. As a result, its current liabilities are equal to approximately 23% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
What We Can Learn From Tractor Supply’s ROCE
Overall, Tractor Supply has a decent ROCE and could be worthy of further research. There might be better investments than Tractor Supply 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.
I will like Tractor Supply 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 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.
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