Should Tabcorp Holdings Limited’s (ASX:TAH) Weak Investment Returns Worry You?

Today we'll evaluate Tabcorp Holdings Limited (ASX:TAH) 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, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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?

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 Tabcorp Holdings:

0.061 = AU$710m ÷ (AU$13b - AU$1.6b) (Based on the trailing twelve months to June 2019.)

Therefore, Tabcorp Holdings has an ROCE of 6.1%.

See our latest analysis for Tabcorp Holdings

Does Tabcorp Holdings Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Tabcorp Holdings's ROCE appears to be significantly below the 12% average in the Hospitality industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Separate from how Tabcorp Holdings stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.

Tabcorp Holdings's current ROCE of 6.1% is lower than its ROCE in the past, which was 11%, 3 years ago. So investors might consider if it has had issues recently. You can click on the image below to see (in greater detail) how Tabcorp Holdings'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 only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Tabcorp Holdings.

Tabcorp Holdings's Current Liabilities And Their Impact On Its 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Tabcorp Holdings has total assets of AU$13b and current liabilities of AU$1.6b. Therefore its current liabilities are equivalent to approximately 12% 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 Tabcorp Holdings's ROCE

With that in mind, we're not overly impressed with Tabcorp Holdings's ROCE, so it may not be the most appealing prospect. 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 like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.