Today we’ll look at Douglas Dynamics, Inc. (NYSE:PLOW) 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, we’ll go over how we 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. 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 Douglas Dynamics:
0.12 = US$73m ÷ (US$676m – US$79m) (Based on the trailing twelve months to December 2018.)
So, Douglas Dynamics has an ROCE of 12%.
Is Douglas Dynamics’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. We can see Douglas Dynamics’s ROCE is around the 12% average reported by the Machinery industry. Independently of how Douglas Dynamics compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Douglas Dynamics’s current ROCE of 12% is lower than its ROCE in the past, which was 17%, 3 years ago. Therefore we wonder if the company is facing new headwinds.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. 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 Douglas Dynamics.
How Douglas Dynamics’s Current Liabilities Impact Its 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 the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counter this, investors can check if a company has high current liabilities relative to total assets.
Douglas Dynamics has total assets of US$676m and current liabilities of US$79m. As a result, its current liabilities are equal to approximately 12% of its total assets. Low current liabilities are not boosting the ROCE too much.
The Bottom Line On Douglas Dynamics’s ROCE
This is good to see, and with a sound ROCE, Douglas Dynamics could be worth a closer look. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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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.