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What Can We Make Of Cabot Corporation’s (NYSE:CBT) High Return On Capital?

Simply Wall St

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Today we'll evaluate Cabot Corporation (NYSE:CBT) 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. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting 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. 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 Cabot:

0.18 = US$391m ÷ (US$3.3b - US$1.1b) (Based on the trailing twelve months to March 2019.)

So, Cabot has an ROCE of 18%.

Check out our latest analysis for Cabot

Does Cabot Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that Cabot's ROCE is meaningfully better than the 11% average in the Chemicals 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 where Cabot sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

Our data shows that Cabot currently has an ROCE of 18%, compared to its ROCE of 11% 3 years ago. This makes us wonder if the company is improving.

NYSE:CBT Past Revenue and Net Income, June 3rd 2019

It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. 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 Cabot.

Do Cabot'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 counter this, investors can check if a company has high current liabilities relative to total assets.

Cabot has total assets of US$3.3b and current liabilities of US$1.1b. As a result, its current liabilities are equal to approximately 35% of its total assets. Cabot has a middling amount of current liabilities, increasing its ROCE somewhat.

What We Can Learn From Cabot's ROCE

With a decent ROCE, the company could be interesting, but remember that the level of current liabilities make the ROCE look better. Cabot looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.

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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.