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Today we'll look at Resolute Forest Products Inc. (NYSE:RFP) 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 up, we'll look at what ROCE is and how we calculate it. 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.
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. 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 Resolute Forest Products:
0.13 = US$434m ÷ (US$3.8b - US$441m) (Based on the trailing twelve months to March 2019.)
Therefore, Resolute Forest Products has an ROCE of 13%.
Is Resolute Forest Products's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. We can see Resolute Forest Products's ROCE is around the 11% average reported by the Forestry industry. Separate from Resolute Forest Products's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
In our analysis, Resolute Forest Products's ROCE appears to be 13%, compared to 3 years ago, when its ROCE was 1.1%. This makes us think the business might be improving. You can see in the image below how Resolute Forest Products'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. 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. How cyclical is Resolute Forest Products? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Resolute Forest Products's Current Liabilities And Their Impact On 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 ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counter this, investors can check if a company has high current liabilities relative to total assets.
Resolute Forest Products has total liabilities of US$441m and total assets of US$3.8b. As a result, its current liabilities are equal to approximately 12% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
Our Take On Resolute Forest Products's ROCE
This is good to see, and with a sound ROCE, Resolute Forest Products could be worth a closer look. Resolute Forest Products looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
I will like Resolute Forest Products better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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.
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. Thank you for reading.