Today we'll evaluate Canfor Pulp Products Inc. (TSE:CFX) to determine whether it could have potential as an investment idea. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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.'
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 Canfor Pulp Products:
0.14 = CA$110m ÷ (CA$937m - CA$164m) (Based on the trailing twelve months to June 2019.)
Therefore, Canfor Pulp Products has an ROCE of 14%.
Is Canfor Pulp Products's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Canfor Pulp Products's ROCE is meaningfully higher than the 8.4% average in the Forestry industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how Canfor Pulp Products compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
You can click on the image below to see (in greater detail) how Canfor Pulp Products's past growth compares to other companies.
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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Canfor Pulp Products's Current Liabilities And Their Impact On 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Canfor Pulp Products has total assets of CA$937m and current liabilities of CA$164m. As a result, its current liabilities are equal to approximately 17% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
The Bottom Line On Canfor Pulp Products's ROCE
Overall, Canfor Pulp Products has a decent ROCE and could be worthy of further research. Canfor Pulp Products 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 email@example.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.