Today we are going to look at AMCON Distributing Company (NYSEMKT:DIT) to see whether it might be an attractive investment prospect. 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 up, we’ll look at what ROCE is and how we calculate it. 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 measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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 AMCON Distributing:
0.074 = US$7.8m ÷ (US$140m – US$34m) (Based on the trailing twelve months to September 2018.)
So, AMCON Distributing has an ROCE of 7.4%.
View our latest analysis for AMCON Distributing
Does AMCON Distributing Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. We can see AMCON Distributing’s ROCE is meaningfully below the Retail Distributors industry average of 16%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Aside from the industry comparison, AMCON Distributing’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
As we can see, AMCON Distributing currently has an ROCE of 7.4%, less than the 13% it reported 3 years ago. This makes us wonder if the business is facing new challenges.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. You can check if AMCON Distributing has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Do AMCON Distributing’s Current Liabilities Skew Its 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) unfairly boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.
AMCON Distributing has total liabilities of US$34m and total assets of US$140m. Therefore its current liabilities are equivalent to approximately 25% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.
What We Can Learn From AMCON Distributing’s ROCE
If AMCON Distributing continues to earn an uninspiring ROCE, there may be better places to invest. But note: AMCON Distributing 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).
But note: AMCON Distributing may not be the best stock to buy. So take a peek at this free list of interesting companies with high ROE and low debt.
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.