Yahoo Finance Should You Like Richelieu Hardware Ltd.’s (TSE:RCH) High Return On Capital Employed?
Today we are going to look at Richelieu Hardware Ltd. (TSE:RCH) to see whether it might be an attractive investment prospect. 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 of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. 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?
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 Richelieu Hardware:
0.18 = CA$93m ÷ (CA$610m - CA$99m) (Based on the trailing twelve months to August 2019.)
So, Richelieu Hardware has an ROCE of 18%.
Check out our latest analysis for Richelieu Hardware
Does Richelieu Hardware Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Richelieu Hardware's ROCE appears to be substantially greater than the 11% average in the Trade Distributors industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Independently of how Richelieu Hardware compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
You can see in the image below how Richelieu Hardware's ROCE compares to its industry. Click to see more on past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Richelieu Hardware.
Do Richelieu Hardware's Current Liabilities Skew 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. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Richelieu Hardware has total liabilities of CA$99m and total assets of CA$610m. Therefore its current liabilities are equivalent to approximately 16% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
The Bottom Line On Richelieu Hardware's ROCE
Overall, Richelieu Hardware has a decent ROCE and could be worthy of further research. There might be better investments than Richelieu Hardware 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.
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.
