Today we'll evaluate Graco Inc. (NYSE:GGG) to determine whether it could have potential as an investment idea. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting 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. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'
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 Graco:
0.33 = US$420m ÷ (US$1.6b - US$360m) (Based on the trailing twelve months to June 2019.)
Therefore, Graco has an ROCE of 33%.
Does Graco Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Graco'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, Graco's ROCE is currently very good.
We can see that , Graco currently has an ROCE of 33% compared to its ROCE 3 years ago, which was 23%. This makes us think about whether the company has been reinvesting shrewdly. The image below shows how Graco's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for Graco.
Graco's Current Liabilities And Their Impact On 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Graco has total assets of US$1.6b and current liabilities of US$360m. As a result, its current liabilities are equal to approximately 22% of its total assets. This is quite a low level of current liabilities which would not greatly boost the already high ROCE.
Our Take On Graco's ROCE
Low current liabilities and high ROCE is a good combination, making Graco look quite interesting. There might be better investments than Graco 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 Graco 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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