Today we'll look at International Flavors & Fragrances Inc. (NYSE:IFF) and reflect on its potential as an investment. 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, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting 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. Generally speaking a higher ROCE is better. 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'.
So, How Do We Calculate ROCE?
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 International Flavors & Fragrances:
0.068 = US$792m ÷ (US$13b - US$1.4b) (Based on the trailing twelve months to September 2019.)
So, International Flavors & Fragrances has an ROCE of 6.8%.
Does International Flavors & Fragrances Have A Good ROCE?
One way to assess ROCE is to compare similar companies. In this analysis, International Flavors & Fragrances's ROCE appears meaningfully below the 10% average reported by the Chemicals industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Setting aside the industry comparison for now, International Flavors & Fragrances's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
International Flavors & Fragrances's current ROCE of 6.8% is lower than 3 years ago, when the company reported a 19% ROCE. This makes us wonder if the business is facing new challenges. You can see in the image below how International Flavors & Fragrances's ROCE compares to its industry. Click to see more on past growth.
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. 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.
How International Flavors & Fragrances'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 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
International Flavors & Fragrances has total liabilities of US$1.4b and total assets of US$13b. As a result, its current liabilities are equal to approximately 11% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
The Bottom Line On International Flavors & Fragrances's ROCE
With that in mind, we're not overly impressed with International Flavors & Fragrances's ROCE, so it may not be the most appealing prospect. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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If you spot an error that warrants correction, please contact the editor at email@example.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.
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