Today we'll look at Genuine Parts Company (NYSE:GPC) and reflect on its potential as an investment. 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. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
What is 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. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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?
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 Genuine Parts:
0.14 = US$1.1b ÷ (US$15b - US$6.4b) (Based on the trailing twelve months to September 2019.)
Therefore, Genuine Parts has an ROCE of 14%.
Is Genuine Parts's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. It appears that Genuine Parts's ROCE is fairly close to the Retail Distributors industry average of 13%. Independently of how Genuine Parts compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Genuine Parts's current ROCE of 14% is lower than 3 years ago, when the company reported a 25% ROCE. Therefore we wonder if the company is facing new headwinds. The image below shows how Genuine Parts's ROCE compares to its industry, and you can click it to see more detail on its past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Genuine Parts.
What Are Current Liabilities, And How Do They Affect Genuine Parts's ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
Genuine Parts has total assets of US$15b and current liabilities of US$6.4b. As a result, its current liabilities are equal to approximately 44% of its total assets. Genuine Parts has a medium level of current liabilities, which would boost the ROCE.
The Bottom Line On Genuine Parts's ROCE
With a decent ROCE, the company could be interesting, but remember that the level of current liabilities make the ROCE look better. Genuine Parts shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
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 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.
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