Today we'll evaluate TripAdvisor, Inc. (NASDAQ:TRIP) to determine whether it could have potential as an investment idea. 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. 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.
Return On Capital Employed (ROCE): What is it?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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 TripAdvisor:
0.11 = US$213m ÷ (US$2.6b - US$638m) (Based on the trailing twelve months to June 2019.)
So, TripAdvisor has an ROCE of 11%.
Is TripAdvisor's ROCE Good?
One way to assess ROCE is to compare similar companies. In our analysis, TripAdvisor's ROCE is meaningfully higher than the 8.7% average in the Interactive Media and Services industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where TripAdvisor sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
In our analysis, TripAdvisor's ROCE appears to be 11%, compared to 3 years ago, when its ROCE was 8.5%. This makes us think about whether the company has been reinvesting shrewdly. You can click on the image below to see (in greater detail) how TripAdvisor's past growth compares to other companies.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for TripAdvisor.
How TripAdvisor's Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
TripAdvisor has total liabilities of US$638m and total assets of US$2.6b. As a result, its current liabilities are equal to approximately 25% of its total assets. Low current liabilities are not boosting the ROCE too much.
What We Can Learn From TripAdvisor's ROCE
Overall, TripAdvisor has a decent ROCE and could be worthy of further research. There might be better investments than TripAdvisor out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
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 email@example.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.