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Evaluating Loblaw Companies Limited’s (TSE:L) Investments In Its Business

Simply Wall St

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Today we are going to look at Loblaw Companies Limited (TSE:L) to see whether it might be an attractive investment prospect. 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. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.

Understanding Return On Capital Employed (ROCE)

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 Loblaw Companies:

0.076 = CA$2.1b ÷ (CA$35b - CA$7.9b) (Based on the trailing twelve months to March 2019.)

So, Loblaw Companies has an ROCE of 7.6%.

Check out our latest analysis for Loblaw Companies

Does Loblaw Companies Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Loblaw Companies's ROCE appears to be around the 9.5% average of the Consumer Retailing industry. Separate from how Loblaw Companies stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.

You can see in the image below how Loblaw Companies's ROCE compares to its industry. Click to see more on past growth.

TSX:L Past Revenue and Net Income, July 2nd 2019

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Do Loblaw Companies's Current Liabilities Skew Its ROCE?

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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.

Loblaw Companies has total assets of CA$35b and current liabilities of CA$7.9b. As a result, its current liabilities are equal to approximately 23% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.

The Bottom Line On Loblaw Companies's ROCE

If Loblaw Companies continues to earn an uninspiring ROCE, there may be better places to invest. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.