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Is Hill & Smith Holdings PLC's (LON:HILS) Capital Allocation Ability Worth Your Time?

Simply Wall St

Today we'll look at Hill & Smith Holdings PLC (LON:HILS) 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, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.

So, How Do We Calculate ROCE?

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 Hill & Smith Holdings:

0.12 = UK£70m ÷ (UK£711m - UK£146m) (Based on the trailing twelve months to June 2019.)

So, Hill & Smith Holdings has an ROCE of 12%.

See our latest analysis for Hill & Smith Holdings

Does Hill & Smith Holdings Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. It appears that Hill & Smith Holdings's ROCE is fairly close to the Metals and Mining industry average of 13%. Independently of how Hill & Smith Holdings compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

You can click on the image below to see (in greater detail) how Hill & Smith Holdings's past growth compares to other companies.

LSE:HILS Past Revenue and Net Income, October 20th 2019

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. Remember that most companies like Hill & Smith Holdings are cyclical businesses. Since the future is so important for investors, you should check out our free report on analyst forecasts for Hill & Smith Holdings.

How Hill & Smith Holdings's Current Liabilities Impact Its ROCE

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counter this, investors can check if a company has high current liabilities relative to total assets.

Hill & Smith Holdings has total liabilities of UK£146m and total assets of UK£711m. As a result, its current liabilities are equal to approximately 20% of its total assets. Low current liabilities are not boosting the ROCE too much.

What We Can Learn From Hill & Smith Holdings's ROCE

This is good to see, and with a sound ROCE, Hill & Smith Holdings could be worth a closer look. Hill & Smith Holdings shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.

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 editorial-team@simplywallst.com. 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.