Today we'll look at H.B. Fuller Company (NYSE:FUL) and reflect on its potential as an investment. 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, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its 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 H.B. Fuller:
0.073 = US$265m ÷ (US$4.2b - US$521m) (Based on the trailing twelve months to March 2019.)
So, H.B. Fuller has an ROCE of 7.3%.
Is H.B. Fuller's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, H.B. Fuller's ROCE appears meaningfully below the 12% average reported by the Chemicals industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Separate from how H.B. Fuller stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.
As we can see, H.B. Fuller currently has an ROCE of 7.3%, less than the 11% it reported 3 years ago. This makes us wonder if the business is facing new challenges.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for H.B. Fuller.
How H.B. Fuller'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.
H.B. Fuller has total liabilities of US$521m and total assets of US$4.2b. Therefore its current liabilities are equivalent to approximately 13% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.
Our Take On H.B. Fuller's ROCE
With that in mind, we're not overly impressed with H.B. Fuller's ROCE, so it may not be the most appealing prospect. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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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.