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Yelp Inc. (NYSE:YELP) Might Not Be A Great Investment

Simply Wall St

Today we'll evaluate Yelp Inc. (NYSE:YELP) 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. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting 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?

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 Yelp:

0.033 = US$31m ÷ (US$1.1b - US$136m) (Based on the trailing twelve months to June 2019.)

So, Yelp has an ROCE of 3.3%.

See our latest analysis for Yelp

Is Yelp's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, Yelp's ROCE appears to be significantly below the 8.7% average in the Interactive Media and Services industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how Yelp compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.7% available in government bonds. There are potentially more appealing investments elsewhere.

Yelp reported an ROCE of 3.3% -- better than 3 years ago, when the company didn't make a profit. That implies the business has been improving. You can click on the image below to see (in greater detail) how Yelp's past growth compares to other companies.

NYSE:YELP Past Revenue and Net Income, August 27th 2019

When considering this metric, keep in mind that it is backwards looking, and 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 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 Yelp.

What Are Current Liabilities, And How Do They Affect Yelp's ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Yelp has total assets of US$1.1b and current liabilities of US$136m. Therefore its current liabilities are equivalent to approximately 13% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.

The Bottom Line On Yelp's ROCE

That's not a bad thing, however Yelp has a weak ROCE and may not be an attractive investment. Of course, you might also be able to find a better stock than Yelp. So you may wish to see this free collection of other companies that have grown earnings strongly.

I will like Yelp better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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.