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Today we'll evaluate Ross Stores, Inc. (NASDAQ:ROST) to determine whether it could have potential as an investment idea. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.

First, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. 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'.

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 Ross Stores:

0.50 = US$2.0b ÷ (US$6.1b - US$2.0b) (Based on the trailing twelve months to February 2019.)

Therefore, Ross Stores has an ROCE of 50%.

View our latest analysis for Ross Stores

Is Ross Stores's ROCE Good?

One way to assess ROCE is to compare similar companies. In our analysis, Ross Stores's ROCE is meaningfully higher than the 13% average in the Specialty Retail industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Putting aside its position relative to its industry for now, in absolute terms, Ross Stores's ROCE is currently very good.

When considering ROCE, bear in mind that it reflects the past and does not necessarily 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.

How Ross Stores's Current Liabilities Impact Its ROCE

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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.

Ross Stores has total assets of US$6.1b and current liabilities of US$2.0b. Therefore its current liabilities are equivalent to approximately 33% of its total assets. A medium level of current liabilities boosts Ross Stores's ROCE somewhat.

What We Can Learn From Ross Stores's ROCE

Still, it has a high ROCE, and may be an interesting prospect for further research. There might be better investments than Ross Stores 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.

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.