Yahoo Finance Why We’re Not Keen On Shake Shack Inc.’s (NYSE:SHAK) 3.8% Return On Capital
Today we'll look at Shake Shack Inc. (NYSE:SHAK) and reflect on its potential as an investment. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. 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. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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?
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 Shake Shack:
0.038 = US$33m ÷ (US$963m - US$96m) (Based on the trailing twelve months to September 2019.)
Therefore, Shake Shack has an ROCE of 3.8%.
Check out our latest analysis for Shake Shack
Does Shake Shack Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, Shake Shack's ROCE appears meaningfully below the 8.5% average reported by the Hospitality industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Regardless of how Shake Shack stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). It is likely that there are more attractive prospects out there.
Shake Shack's current ROCE of 3.8% is lower than 3 years ago, when the company reported a 5.6% ROCE. This makes us wonder if the business is facing new challenges. You can click on the image below to see (in greater detail) how Shake Shack's past growth compares to other companies.
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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Shake Shack.
How Shake Shack's Current Liabilities Impact 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Shake Shack has total liabilities of US$96m and total assets of US$963m. Therefore its current liabilities are equivalent to approximately 10.0% of its total assets. Shake Shack has very few current liabilities, which have a minimal effect on its already low ROCE.
Our Take On Shake Shack's ROCE
Still, investors could probably find more attractive prospects with better performance out there. You might be able to find a better investment than Shake Shack. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
If you are like me, then you will not want to miss this free list of growing companies that insiders are 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.
