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Today we'll look at Rocky Mountain Chocolate Factory, Inc. ( NASDAQ:RMCF ) 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. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
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. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'
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 Rocky Mountain Chocolate Factory:
0.14 = US$3.3m ÷ (US$30m - US$5.5m) (Based on the trailing twelve months to May 2019.)
So, Rocky Mountain Chocolate Factory has an ROCE of 14%.
Is Rocky Mountain Chocolate Factory's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Rocky Mountain Chocolate Factory's ROCE is meaningfully better than the 8.2% average in the Food industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where Rocky Mountain Chocolate Factory sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Rocky Mountain Chocolate Factory's current ROCE of 14% is lower than 3 years ago, when the company reported a 27% ROCE. So investors might consider if it has had issues recently. The image below shows how Rocky Mountain Chocolate Factory's ROCE compares to its industry, and you can click it to see more detail on its past growth.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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. If Rocky Mountain Chocolate Factory is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow .
Do Rocky Mountain Chocolate Factory's Current Liabilities Skew Its ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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.
Rocky Mountain Chocolate Factory has total assets of US$30m and current liabilities of US$5.5m. Therefore its current liabilities are equivalent to approximately 19% of its total assets. Low current liabilities are not boosting the ROCE too much.
The Bottom Line On Rocky Mountain Chocolate Factory's ROCE
Overall, Rocky Mountain Chocolate Factory has a decent ROCE and could be worthy of further research. Rocky Mountain Chocolate Factory looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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 firstname.lastname@example.org . 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.