Today we'll look at Ashland Global Holdings Inc. (NYSE:ASH) 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. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
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 Ashland Global Holdings:
0.05 = US$345m ÷ (US$7.9b - US$1.0b) (Based on the trailing twelve months to June 2019.)
Therefore, Ashland Global Holdings has an ROCE of 5.0%.
Is Ashland Global Holdings's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In this analysis, Ashland Global Holdings's ROCE appears meaningfully below the 10% average reported by the Chemicals industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Regardless of how Ashland Global Holdings stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). It is likely that there are more attractive prospects out there.
In our analysis, Ashland Global Holdings's ROCE appears to be 5.0%, compared to 3 years ago, when its ROCE was 1.3%. This makes us think about whether the company has been reinvesting shrewdly. The image below shows how Ashland Global Holdings's ROCE compares to its industry, and you can click it to see more detail on its 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect Ashland Global Holdings's 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 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.
Ashland Global Holdings has total assets of US$7.9b and current liabilities of US$1.0b. As a result, its current liabilities are equal to approximately 13% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.
Our Take On Ashland Global Holdings's ROCE
That's not a bad thing, however Ashland Global Holdings has a weak ROCE and may not be an attractive investment. Of course, you might also be able to find a better stock than Ashland Global Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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 firstname.lastname@example.org. 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.