Today we are going to look at PACCAR Inc (NASDAQ:PCAR) 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, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting 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. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
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 PACCAR:
0.13 = US$3.0b ÷ (US$28b - US$6.0b) (Based on the trailing twelve months to December 2019.)
So, PACCAR has an ROCE of 13%.
Does PACCAR Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. PACCAR's ROCE appears to be substantially greater than the 11% average in the Machinery industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from PACCAR's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
You can see in the image below how PACCAR's ROCE compares to its industry. Click to see more on past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for PACCAR.
What Are Current Liabilities, And How Do They Affect PACCAR's ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
PACCAR has total assets of US$28b and current liabilities of US$6.0b. As a result, its current liabilities are equal to approximately 21% of its total assets. Low current liabilities are not boosting the ROCE too much.
What We Can Learn From PACCAR's ROCE
Overall, PACCAR has a decent ROCE and could be worthy of further research. PACCAR looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
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 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.
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