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Donaldson Company, Inc. (NYSE:DCI) Is Employing Capital Very Effectively

Simply Wall St
·4 mins read

Today we are going to look at Donaldson Company, Inc. (NYSE:DCI) 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. 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. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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?

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 Donaldson Company:

0.22 = US$378m ÷ (US$2.3b - US$531m) (Based on the trailing twelve months to October 2019.)

Therefore, Donaldson Company has an ROCE of 22%.

Check out our latest analysis for Donaldson Company

Is Donaldson Company's ROCE Good?

One way to assess ROCE is to compare similar companies. In our analysis, Donaldson Company's ROCE is meaningfully higher than the 11% average in the Machinery industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Putting aside its position relative to its industry for now, in absolute terms, Donaldson Company's ROCE is currently very good.

The image below shows how Donaldson Company's ROCE compares to its industry, and you can click it to see more detail on its past growth.

NYSE:DCI Past Revenue and Net Income, February 26th 2020
NYSE:DCI Past Revenue and Net Income, February 26th 2020

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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, 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.

How Donaldson Company's Current Liabilities Impact Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Donaldson Company has current liabilities of US$531m and total assets of US$2.3b. As a result, its current liabilities are equal to approximately 23% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.

What We Can Learn From Donaldson Company's ROCE

Low current liabilities and high ROCE is a good combination, making Donaldson Company look quite interesting. There might be better investments than Donaldson Company 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 editorial-team@simplywallst.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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.