Today we'll look at Herc Holdings Inc. (NYSE:HRI) and reflect on its potential as an investment. 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.
First of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its 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?
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 Herc Holdings:
0.063 = US$211m ÷ (US$3.7b - US$336m) (Based on the trailing twelve months to March 2019.)
Therefore, Herc Holdings has an ROCE of 6.3%.
Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!
Is Herc Holdings's ROCE Good?
One way to assess ROCE is to compare similar companies. In this analysis, Herc Holdings's ROCE appears meaningfully below the 8.2% average reported by the Trade Distributors industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Separate from how Herc Holdings stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.
In our analysis, Herc Holdings's ROCE appears to be 6.3%, compared to 3 years ago, when its ROCE was 4.3%. This makes us think the business might be improving.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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 only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Herc Holdings.
Do Herc 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Herc Holdings has total liabilities of US$336m and total assets of US$3.7b. As a result, its current liabilities are equal to approximately 9.2% of its total assets. With low levels of current liabilities, at least Herc Holdings's mediocre ROCE is not unduly boosted.
What We Can Learn From Herc Holdings's ROCE
Based on this information, Herc Holdings appears to be a mediocre business. You might be able to find a better investment than Herc Holdings. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
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.