What Can We Make Of Williams-Sonoma, Inc.’s (NYSE:WSM) High Return On Capital?

Today we are going to look at Williams-Sonoma, Inc. (NYSE:WSM) to see whether it might be an attractive investment prospect. 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 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 measures the amount of pre-tax profits a company can generate from the capital employed 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?

Analysts use this formula to calculate return on capital employed:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)

Or for Williams-Sonoma:

0.18 = US$473m ÷ (US$4.0b – US$1.3b) (Based on the trailing twelve months to November 2019.)

Therefore, Williams-Sonoma has an ROCE of 18%.

See our latest analysis for Williams-Sonoma

Does Williams-Sonoma Have A Good ROCE?

One way to assess ROCE is to compare similar companies. Williams-Sonoma’s ROCE appears to be substantially greater than the 11% average in the Specialty Retail industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Regardless of where Williams-Sonoma sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

Williams-Sonoma’s current ROCE of 18% is lower than its ROCE in the past, which was 35%, 3 years ago. So investors might consider if it has had issues recently. The image below shows how Williams-Sonoma’s ROCE compares to its industry, and you can click it to see more detail on its past growth.

NYSE:WSM Past Revenue and Net Income, January 29th 2020
NYSE:WSM Past Revenue and Net Income, January 29th 2020

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the 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 Williams-Sonoma.

Williams-Sonoma’s Current Liabilities And Their Impact On Its ROCE

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Williams-Sonoma has total assets of US$4.0b and current liabilities of US$1.3b. As a result, its current liabilities are equal to approximately 33% of its total assets. Williams-Sonoma has a medium level of current liabilities, which would boost the ROCE.

What We Can Learn From Williams-Sonoma’s ROCE

While its ROCE looks good, it’s worth remembering that the current liabilities are making the business look better. Williams-Sonoma shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.

I will like Williams-Sonoma 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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