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Today we’ll evaluate Hormel Foods Corporation (NYSE:HRL) to determine whether it could have potential as an investment idea. 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. Second, we’ll look at its ROCE compared 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 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. In brief, it is a useful tool, but it is not without drawbacks. 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 Hormel Foods:
0.17 = US$1.2b ÷ (US$8.1b – US$1.1b) (Based on the trailing twelve months to October 2018.)
So, 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 8.8% average in the Food 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. 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.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. 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.
What Are Current Liabilities, And How Do They Affect Hormel Foods’s ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
Hormel Foods has total assets of US$8.1b and current liabilities of US$1.1b. Therefore its current liabilities are equivalent to approximately 14% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
The Bottom Line On Hormel Foods’s ROCE
With that in mind, Hormel Foods’s ROCE appears pretty good. But note: Hormel Foods may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
I will like Hormel Foods better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.