Today we'll look at Generac Holdings Inc. (NYSE:GNRC) and reflect on its potential as an investment. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First up, we'll look at what ROCE is and how we calculate it. 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.
Return On Capital Employed (ROCE): What is it?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. 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'.
So, How Do We Calculate ROCE?
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 Generac Holdings:
0.18 = US$377m ÷ (US$2.5b - US$480m) (Based on the trailing twelve months to June 2019.)
Therefore, Generac Holdings has an ROCE of 18%.
Does Generac Holdings Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Generac Holdings's ROCE is meaningfully higher than the 11% average in the Electrical industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where Generac Holdings sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
In our analysis, Generac Holdings's ROCE appears to be 18%, compared to 3 years ago, when its ROCE was 13%. This makes us wonder if the company is improving. You can see in the image below how Generac Holdings's ROCE compares to its industry. Click to see more on past growth.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Generac Holdings.
Do Generac Holdings's Current Liabilities Skew 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. 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.
Generac Holdings has total assets of US$2.5b and current liabilities of US$480m. Therefore its current liabilities are equivalent to approximately 19% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
Our Take On Generac Holdings's ROCE
With that in mind, Generac Holdings's ROCE appears pretty good. Generac Holdings 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.
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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.