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Roots Corporation (TSE:ROOT) Might Not Be A Great Investment

Today we'll look at Roots Corporation (TSE:ROOT) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect 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. Generally speaking a higher ROCE is better. 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.

How Do You Calculate Return On Capital Employed?

Analysts use this formula to calculate return on capital employed:

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

Or for Roots:

0.043 = CA$20m ÷ (CA$545m - CA$76m) (Based on the trailing twelve months to November 2019.)

Therefore, Roots has an ROCE of 4.3%.

See our latest analysis for Roots

Does Roots Have A Good ROCE?

One way to assess ROCE is to compare similar companies. We can see Roots's ROCE is meaningfully below the Specialty Retail industry average of 10%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Regardless of how Roots stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). Readers may wish to look for more rewarding investments.

Roots's current ROCE of 4.3% is lower than its ROCE in the past, which was 6.4%, 3 years ago. This makes us wonder if the business is facing new challenges. The image below shows how Roots's ROCE compares to its industry, and you can click it to see more detail on its past growth.

TSX:ROOT Past Revenue and Net Income, February 17th 2020
TSX:ROOT Past Revenue and Net Income, February 17th 2020

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 only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Roots.

How Roots's Current Liabilities Impact 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Roots has total assets of CA$545m and current liabilities of CA$76m. As a result, its current liabilities are equal to approximately 14% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.

The Bottom Line On Roots's ROCE

While that is good to see, Roots has a low ROCE and does not look attractive in this analysis. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

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

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. Thank you for reading.