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Today we are going to look at HNI Corporation (NYSE:HNI) to see whether it might be an attractive investment prospect. 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 of all, we’ll work out how to calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. And finally, we’ll look at how its current liabilities are impacting 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. Generally speaking a higher ROCE is better. 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 HNI:
0.13 = US$139m ÷ (US$1.4b – US$436m) (Based on the trailing twelve months to September 2018.)
Therefore, HNI has an ROCE of 13%.
Does HNI Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, HNI’s ROCE appears to be around the 11% average of the Commercial Services industry. Independently of how HNI compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
As we can see, HNI currently has an ROCE of 13%, less than the 26% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds.
When considering this metric, keep in mind that it is backwards looking, and 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for HNI.
Do HNI’s Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
HNI has total liabilities of US$436m and total assets of US$1.4b. Therefore its current liabilities are equivalent to approximately 31% of its total assets. HNI has a medium level of current liabilities, which would boost the ROCE.
What We Can Learn From HNI’s ROCE
While its ROCE looks good, it’s worth remembering that the current liabilities are making the business look better. But note: HNI may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
If you are like me, then you will not want to miss this free list of growing companies that insiders are 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 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. On rare occasion, data errors may occur. Thank you for reading.