Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!
Today we'll evaluate Hormel Foods Corporation (NYSE:HRL) to determine whether it could have potential as an investment idea. 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. Last but not least, we'll look at what impact its current liabilities have on 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. All else being equal, a better business will have a higher ROCE. 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'.
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 Hormel Foods:
0.17 = US$1.2b ÷ (US$7.9b - US$1.1b) (Based on the trailing twelve months to April 2019.)
Therefore, Hormel Foods has an ROCE of 17%.
Does Hormel Foods Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Hormel Foods's ROCE appears to be substantially greater than the 8.2% average in the Food industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where Hormel Foods sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Hormel Foods's current ROCE of 17% is lower than its ROCE in the past, which was 23%, 3 years ago. Therefore we wonder if the company is facing new headwinds. You can see in the image below how Hormel Foods's ROCE compares to its industry. Click to see more on past growth.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for Hormel Foods.
Do Hormel Foods's Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
Hormel Foods has total liabilities of US$1.1b and total assets of US$7.9b. As a result, its current liabilities are equal to approximately 13% of its total assets. Low current liabilities are not boosting the ROCE too much.
The Bottom Line On Hormel Foods's ROCE
Overall, Hormel Foods has a decent ROCE and could be worthy of further research. There might be better investments than Hormel Foods 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 are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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.