Today we are going to look at Federal Signal Corporation (NYSE:FSS) 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 up, we’ll look at what ROCE is and how we calculate it. Next, we’ll compare it to others in its industry. Then we’ll determine how its current liabilities are affecting its ROCE.
Understanding Return On Capital Employed (ROCE)
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?
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 Federal Signal:
0.13 = US$77m ÷ (US$1.0b – US$155m) (Based on the trailing twelve months to September 2018.)
Therefore, Federal Signal has an ROCE of 13%.
Does Federal Signal Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. We can see Federal Signal’s ROCE is around the 12% average reported by the Machinery industry. Separate from Federal Signal’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Federal Signal’s current ROCE of 13% is lower than 3 years ago, when the company reported a 20% ROCE. So investors might consider if it has had issues recently.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Federal Signal’s Current Liabilities And Their Impact On Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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.
Federal Signal has total liabilities of US$155m and total assets of US$1.0b. As a result, its current liabilities are equal to approximately 15% of its total assets. Low current liabilities are not boosting the ROCE too much.
Our Take On Federal Signal’s ROCE
Overall, Federal Signal has a decent ROCE and could be worthy of further research. Of course you might be able to find a better stock than Federal Signal. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like Federal Signal better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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 firstname.lastname@example.org.