Today we'll look at EMCOR Group, Inc. (NYSE:EME) 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.
First, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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 EMCOR Group:
0.17 = US$448m ÷ (US$4.4b - US$1.7b) (Based on the trailing twelve months to June 2019.)
Therefore, EMCOR Group has an ROCE of 17%.
Does EMCOR Group Have A Good ROCE?
One way to assess ROCE is to compare similar companies. In our analysis, EMCOR Group's ROCE is meaningfully higher than the 9.7% average in the Construction industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of where EMCOR Group sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
We can see that , EMCOR Group currently has an ROCE of 17% compared to its ROCE 3 years ago, which was 13%. This makes us think the business might be improving. You can see in the image below how EMCOR Group'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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for EMCOR Group.
How EMCOR Group's Current Liabilities Impact 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
EMCOR Group has total assets of US$4.4b and current liabilities of US$1.7b. Therefore its current liabilities are equivalent to approximately 39% of its total assets. With this level of current liabilities, EMCOR Group's ROCE is boosted somewhat.
Our Take On EMCOR Group's ROCE
EMCOR Group's ROCE does look good, but the level of current liabilities also contribute to that. There might be better investments than EMCOR Group 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.
I will like EMCOR Group better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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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. Thank you for reading.