Today we are going to look at International Flavors & Fragrances Inc. (NYSE:IFF) to see whether it might be an attractive investment prospect. 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.
What is Return On Capital Employed (ROCE)?
ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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?
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 International Flavors & Fragrances:
0.059 = US$699m ÷ (US$13b – US$1.1b) (Based on the trailing twelve months to December 2018.)
So, International Flavors & Fragrances has an ROCE of 5.9%.
Is International Flavors & Fragrances’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, International Flavors & Fragrances’s ROCE appears meaningfully below the 12% average reported by the Chemicals industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Aside from the industry comparison, International Flavors & Fragrances’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.
International Flavors & Fragrances’s current ROCE of 5.9% is lower than 3 years ago, when the company reported a 21% ROCE. This makes us wonder if the business is facing new challenges.
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, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for International Flavors & Fragrances.
What Are Current Liabilities, And How Do They Affect International Flavors & Fragrances’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. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
International Flavors & Fragrances has total assets of US$13b and current liabilities of US$1.1b. Therefore its current liabilities are equivalent to approximately 8.8% of its total assets. With low levels of current liabilities, at least International Flavors & Fragrances’s mediocre ROCE is not unduly boosted.
Our Take On International Flavors & Fragrances’s ROCE
International Flavors & Fragrances looks like an ok business, but on this analysis it is not at the top of our buy list. Of course you might be able to find a better stock than International Flavors & Fragrances. So you may wish to see this free collection of other companies that have grown earnings strongly.
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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