Today we are going to look at Colgate-Palmolive Company (NYSE:CL) 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. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. 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'.
So, How Do We Calculate ROCE?
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 Colgate-Palmolive:
0.33 = US$3.6b ÷ (US$15b - US$4.0b) (Based on the trailing twelve months to December 2019.)
Therefore, Colgate-Palmolive has an ROCE of 33%.
Does Colgate-Palmolive Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Colgate-Palmolive's ROCE appears to be substantially greater than the 13% average in the Household Products industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Putting aside its position relative to its industry for now, in absolute terms, Colgate-Palmolive's ROCE is currently very good.
Colgate-Palmolive's current ROCE of 33% is lower than 3 years ago, when the company reported a 45% ROCE. So investors might consider if it has had issues recently. You can see in the image below how Colgate-Palmolive's ROCE compares to its industry. Click to see more on past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. 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 Colgate-Palmolive.
Do Colgate-Palmolive's Current Liabilities Skew 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Colgate-Palmolive has current liabilities of US$4.0b and total assets of US$15b. Therefore its current liabilities are equivalent to approximately 27% of its total assets. The fairly low level of current liabilities won't have much impact on the already great ROCE.
What We Can Learn From Colgate-Palmolive's ROCE
With low current liabilities and a high ROCE, Colgate-Palmolive could be worthy of further investigation. There might be better investments than Colgate-Palmolive out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.
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