Why We’re Not Keen On Acorn International, Inc.’s (NYSE:ATV) 3.9% Return On Capital

Today we’ll evaluate Acorn International, Inc. (NYSE:ATV) to determine whether it could have potential as an investment idea. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.

First up, we’ll look at what ROCE is and how we calculate it. Second, we’ll look at its ROCE compared to similar companies. Finally, we’ll look at how its current liabilities affect 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. 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 Acorn International:

0.039 = US$2.9m ÷ (US$91m – US$17m) (Based on the trailing twelve months to December 2018.)

So, Acorn International has an ROCE of 3.9%.

See our latest analysis for Acorn International

Is Acorn International’s ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Acorn International’s ROCE appears to be significantly below the 11% average in the Online Retail industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Independently of how Acorn International compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.7% available in government bonds. There are potentially more appealing investments elsewhere.

Acorn International reported an ROCE of 3.9% — better than 3 years ago, when the company didn’t make a profit. That suggests the business has returned to profitability.

NYSE:ATV Past Revenue and Net Income, March 12th 2019
NYSE:ATV Past Revenue and Net Income, March 12th 2019

When considering ROCE, bear in mind that it reflects the past and does not necessarily 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 only a point-in-time measure. If Acorn International is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

How Acorn International’s Current Liabilities Impact Its ROCE

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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.

Acorn International has total assets of US$91m and current liabilities of US$17m. As a result, its current liabilities are equal to approximately 18% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.

Our Take On Acorn International’s ROCE

While that is good to see, Acorn International has a low ROCE and does not look attractive in this analysis. Of course you might be able to find a better stock than Acorn International. So you may wish to see this free collection of other companies that have grown earnings strongly.

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

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 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. Thank you for reading.