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Are Avery Dennison Corporation’s (NYSE:AVY) High Returns Really That Great?

Simply Wall St

Today we are going to look at Avery Dennison Corporation (NYSE:AVY) 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 up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE 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. 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 Avery Dennison:

0.26 = US$794m ÷ (US$5.4b - US$2.3b) (Based on the trailing twelve months to June 2019.)

Therefore, Avery Dennison has an ROCE of 26%.

View our latest analysis for Avery Dennison

Is Avery Dennison's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Avery Dennison's ROCE is meaningfully better than the 10% average in the Packaging industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Setting aside the comparison to its industry for a moment, Avery Dennison's ROCE in absolute terms currently looks quite high.

You can see in the image below how Avery Dennison's ROCE compares to its industry. Click to see more on past growth.

NYSE:AVY Past Revenue and Net Income, October 2nd 2019

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 only a point-in-time measure. 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 Avery Dennison's ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.

Avery Dennison has total liabilities of US$2.3b and total assets of US$5.4b. Therefore its current liabilities are equivalent to approximately 42% of its total assets. A medium level of current liabilities boosts Avery Dennison's ROCE somewhat.

Our Take On Avery Dennison's ROCE

Even so, it has a great ROCE, and could be an attractive prospect for further research. Avery Dennison 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 Avery Dennison better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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.