Today we'll look at 3M Company (NYSE:MMM) and reflect on its potential as an investment. 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 up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting 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. 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. 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?
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 3M:
0.21 = US$7.3b ÷ (US$43b - US$7.8b) (Based on the trailing twelve months to September 2019.)
Therefore, 3M has an ROCE of 21%.
Does 3M Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that 3M's ROCE is meaningfully better than the 14% average in the Industrials 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. Regardless of the industry comparison, in absolute terms, 3M's ROCE currently appears to be excellent.
You can click on the image below to see (in greater detail) how 3M's past growth compares to other companies.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for 3M.
How 3M's Current Liabilities Impact Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that 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 counter this, investors can check if a company has high current liabilities relative to total assets.
3M has total liabilities of US$7.8b and total assets of US$43b. Therefore its current liabilities are equivalent to approximately 18% of its total assets. The fairly low level of current liabilities won't have much impact on the already great ROCE.
Our Take On 3M's ROCE
This is good to see, and with such a high ROCE, 3M may be worth a closer look. 3M shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
I will like 3M better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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