Today we are going to look at James Hardie Industries plc (ASX:JHX) 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 of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the 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. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.
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 James Hardie Industries:
0.14 = US$488m ÷ (US$4.0b - US$510m) (Based on the trailing twelve months to March 2020.)
Therefore, James Hardie Industries has an ROCE of 14%.
Does James Hardie Industries Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that James Hardie Industries's ROCE is meaningfully better than the 6.2% average in the Basic Materials industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of where James Hardie Industries sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
James Hardie Industries's current ROCE of 14% is lower than 3 years ago, when the company reported a 22% ROCE. So investors might consider if it has had issues recently. You can see in the image below how James Hardie Industries's ROCE compares to its industry. Click to see more on past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the 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.
James Hardie Industries's Current Liabilities And Their Impact On Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
James Hardie Industries has total assets of US$4.0b and current liabilities of US$510m. Therefore its current liabilities are equivalent to approximately 13% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
Our Take On James Hardie Industries's ROCE
This is good to see, and with a sound ROCE, James Hardie Industries could be worth a closer look. James Hardie 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).
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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.