Today we'll evaluate HD Supply Holdings, Inc. (NASDAQ:HDS) 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 of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. 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?
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 HD Supply Holdings:
0.19 = US$737m ÷ (US$4.8b - US$907m) (Based on the trailing twelve months to November 2019.)
So, HD Supply Holdings has an ROCE of 19%.
Does HD Supply Holdings Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. HD Supply Holdings's ROCE appears to be substantially greater than the 10% average in the Trade Distributors industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how HD Supply Holdings compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Our data shows that HD Supply Holdings currently has an ROCE of 19%, compared to its ROCE of 12% 3 years ago. This makes us think the business might be improving. The image below shows how HD Supply Holdings'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. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for HD Supply Holdings.
Do HD Supply Holdings's Current Liabilities Skew 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 counter this, investors can check if a company has high current liabilities relative to total assets.
HD Supply Holdings has total assets of US$4.8b and current liabilities of US$907m. As a result, its current liabilities are equal to approximately 19% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
What We Can Learn From HD Supply Holdings's ROCE
This is good to see, and with a sound ROCE, HD Supply Holdings could be worth a closer look. There might be better investments than HD Supply 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).
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.
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