Why Party City Holdco Inc.’s (NYSE:PRTY) Return On Capital Employed Looks Uninspiring

Today we’ll evaluate Party City Holdco Inc. (NYSE:PRTY) to determine whether it could have potential as an investment idea. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into 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.

What is Return On Capital Employed (ROCE)?

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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 Party City Holdco:

0.099 = US$291m ÷ (US$3.6b – US$711m) (Based on the trailing twelve months to December 2018.)

So, Party City Holdco has an ROCE of 9.9%.

Check out our latest analysis for Party City Holdco

Does Party City Holdco Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. In this analysis, Party City Holdco’s ROCE appears meaningfully below the 13% average reported by the Specialty Retail industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Separate from how Party City Holdco stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.

NYSE:PRTY Past Revenue and Net Income, March 26th 2019
NYSE:PRTY Past Revenue and Net Income, March 26th 2019

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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

What Are Current Liabilities, And How Do They Affect Party City Holdco’s ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Party City Holdco has total assets of US$3.6b and current liabilities of US$711m. As a result, its current liabilities are equal to approximately 20% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.

Our Take On Party City Holdco’s ROCE

With that in mind, we’re not overly impressed with Party City Holdco’s ROCE, so it may not be the most appealing prospect. Of course you might be able to find a better stock than Party City Holdco. So you may wish to see this free collection of other companies that have grown earnings strongly.

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 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.