Today we'll evaluate Armstrong World Industries, Inc. (NYSE:AWI) 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, we'll go over how we 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.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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. 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?
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 Armstrong World Industries:
0.19 = US$246m ÷ (US$1.9b - US$582m) (Based on the trailing twelve months to June 2019.)
So, Armstrong World Industries has an ROCE of 19%.
Is Armstrong World Industries's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Armstrong World Industries's ROCE is meaningfully better than the 12% average in the Building industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how Armstrong World Industries compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Our data shows that Armstrong World Industries currently has an ROCE of 19%, compared to its ROCE of 8.5% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly. You can click on the image below to see (in greater detail) how Armstrong World Industries's past growth compares to other companies.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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 Armstrong World Industries.
What Are Current Liabilities, And How Do They Affect Armstrong World Industries's ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Armstrong World Industries has total liabilities of US$582m and total assets of US$1.9b. Therefore its current liabilities are equivalent to approximately 31% of its total assets. With this level of current liabilities, Armstrong World Industries's ROCE is boosted somewhat.
What We Can Learn From Armstrong World Industries's ROCE
With a decent ROCE, the company could be interesting, but remember that the level of current liabilities make the ROCE look better. Armstrong World Industries shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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 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.