Today we’ll evaluate Builders FirstSource, Inc. (NASDAQ:BLDR) to determine whether it could have potential as an investment idea. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First of all, we’ll work out how to calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. 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?
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 Builders FirstSource:
0.14 = US$289m ÷ (US$3.2b – US$772m) (Based on the trailing twelve months to September 2018.)
Therefore, Builders FirstSource has an ROCE of 14%.
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Is Builders FirstSource’s ROCE Good?
One way to assess ROCE is to compare similar companies. It appears that Builders FirstSource’s ROCE is fairly close to the Building industry average of 14%. Separate from Builders FirstSource’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
As we can see, Builders FirstSource currently has an ROCE of 14% compared to its ROCE 3 years ago, which was 4.0%. This makes us wonder if the company is improving.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. 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 Builders FirstSource.
How Builders FirstSource’s Current Liabilities Impact Its 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.
Builders FirstSource has total liabilities of US$772m and total assets of US$3.2b. As a result, its current liabilities are equal to approximately 24% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
The Bottom Line On Builders FirstSource’s ROCE
Overall, Builders FirstSource has a decent ROCE and could be worthy of further research. Of course you might be able to find a better stock than Builders FirstSource. 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).
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.