Are Floor & Decor Holdings, Inc.’s (NYSE:FND) High Returns Really That Great?

Today we’ll look at Floor & Decor Holdings, Inc. (NYSE:FND) and reflect on its potential as an investment. 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 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.

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 Floor & Decor Holdings:

0.17 = US$118m ÷ (US$1.1b – US$324m) (Based on the trailing twelve months to September 2018.)

Therefore, Floor & Decor Holdings has an ROCE of 17%.

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Does Floor & Decor Holdings Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Floor & Decor Holdings’s ROCE is meaningfully higher than the 13% average in the Specialty Retail industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from Floor & Decor Holdings’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

As we can see, Floor & Decor Holdings currently has an ROCE of 17% compared to its ROCE 3 years ago, which was 8.0%. This makes us wonder if the company is improving.

NYSE:FND Last Perf January 22nd 19
NYSE:FND Last Perf January 22nd 19

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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Floor & Decor Holdings.

How Floor & Decor Holdings’s Current Liabilities Impact Its 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.

Floor & Decor Holdings has total liabilities of US$324m and total assets of US$1.1b. As a result, its current liabilities are equal to approximately 29% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.

Our Take On Floor & Decor Holdings’s ROCE

Overall, Floor & Decor Holdings has a decent ROCE and could be worthy of further research. But note: Floor & Decor Holdings may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.