Today we'll look at NVR, Inc. (NYSE:NVR) and reflect on its potential as an investment. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the 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. 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 NVR:
0.34 = US$1.0b ÷ (US$3.8b - US$782m) (Based on the trailing twelve months to September 2019.)
Therefore, NVR has an ROCE of 34%.
Is NVR's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. NVR's ROCE appears to be substantially greater than the 12% average in the Consumer Durables industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Setting aside the comparison to its industry for a moment, NVR's ROCE in absolute terms currently looks quite high.
You can click on the image below to see (in greater detail) how NVR's past growth compares to other companies.
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 misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the 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 NVR.
What Are Current Liabilities, And How Do They Affect NVR's ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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.
NVR has total assets of US$3.8b and current liabilities of US$782m. Therefore its current liabilities are equivalent to approximately 20% of its total assets. The fairly low level of current liabilities won't have much impact on the already great ROCE.
The Bottom Line On NVR's ROCE
Low current liabilities and high ROCE is a good combination, making NVR look quite interesting. NVR looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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