Today we are going to look at Harvey Norman Holdings Limited (ASX:HVN) to see whether it might be an attractive investment prospect. 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.
Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. 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. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'
How Do You Calculate Return On Capital Employed?
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 Harvey Norman Holdings:
0.12 = AU$462m ÷ (AU$4.8b - AU$1.0b) (Based on the trailing twelve months to December 2018.)
So, Harvey Norman Holdings has an ROCE of 12%.
Is Harvey Norman Holdings's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. We can see Harvey Norman Holdings's ROCE is around the 12% average reported by the Multiline Retail industry. Independently of how Harvey Norman Holdings compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
You can see in the image below how Harvey Norman Holdings's ROCE compares to its industry. Click to see more on 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Harvey Norman Holdings.
How Harvey Norman Holdings's Current Liabilities Impact 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Harvey Norman Holdings has total assets of AU$4.8b and current liabilities of AU$1.0b. Therefore its current liabilities are equivalent to approximately 21% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
Our Take On Harvey Norman Holdings's ROCE
With that in mind, Harvey Norman Holdings's ROCE appears pretty good. There might be better investments than Harvey Norman Holdings 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.
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.