Today we'll look at Commercial Metals Company (NYSE:CMC) and reflect on its potential as an investment. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. 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 Commercial Metals:
0.15 = US$486m ÷ (US$3.8b - US$602m) (Based on the trailing twelve months to November 2019.)
So, Commercial Metals has an ROCE of 15%.
Does Commercial Metals Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Commercial Metals's ROCE appears to be substantially greater than the 8.5% average in the Metals and Mining industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from Commercial Metals's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
We can see that, Commercial Metals currently has an ROCE of 15% compared to its ROCE 3 years ago, which was 6.5%. This makes us think the business might be improving. You can see in the image below how Commercial Metals's ROCE compares to its industry. Click to see more on past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Given the industry it operates in, Commercial Metals could be considered cyclical. Since the future is so important for investors, you should check out our free report on analyst forecasts for Commercial Metals.
Do Commercial Metals's Current Liabilities Skew 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Commercial Metals has total assets of US$3.8b and current liabilities of US$602m. Therefore its current liabilities are equivalent to approximately 16% of its total assets. Low current liabilities are not boosting the ROCE too much.
Our Take On Commercial Metals's ROCE
This is good to see, and with a sound ROCE, Commercial Metals could be worth a closer look. Commercial Metals 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.
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 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.
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