Today we are going to look at D.R. Horton, Inc. (NYSE:DHI) to see whether it might be an attractive investment prospect. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Last but not least, we’ll look at what impact its current liabilities have on 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. Ultimately, it is a useful but imperfect metric. 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 D.R. Horton:
0.17 = US$2.0b ÷ (US$14b – US$2.4b) (Based on the trailing twelve months to September 2018.)
Therefore, D.R. Horton has an ROCE of 17%.
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Is D.R. Horton’s ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, we find that D.R. Horton’s ROCE is meaningfully better than the 11% average in the Consumer Durables industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from D.R. Horton’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
In our analysis, D.R. Horton’s ROCE appears to be 17%, compared to 3 years ago, when its ROCE was 13%. This makes us wonder if the company is improving.
When considering this metric, keep in mind that it is backwards looking, and 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 only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
How D.R. Horton’s Current Liabilities Impact 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
D.R. Horton has total liabilities of US$2.4b and total assets of US$14b. Therefore its current liabilities are equivalent to approximately 17% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
What We Can Learn From D.R. Horton’s ROCE
Overall, D.R. Horton has a decent ROCE and could be worthy of further research. Of course you might be able to find a better stock than D.R. Horton. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.