U.S. Markets closed

Is James Hardie Industries plc’s (ASX:JHX) 12% Return On Capital Employed Good News?

Simply Wall St

Want to participate in a research study? Help shape the future of investing tools and earn a $60 gift card!

Today we'll look at James Hardie Industries plc (ASX:JHX) 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. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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. 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 James Hardie Industries:

0.12 = US$423m ÷ (US$4.0b - US$539m) (Based on the trailing twelve months to December 2018.)

Therefore, James Hardie Industries has an ROCE of 12%.

Check out our latest analysis for James Hardie Industries

Does James Hardie Industries Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. It appears that James Hardie Industries's ROCE is fairly close to the Basic Materials industry average of 11%. Separate from James Hardie Industries's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

James Hardie Industries's current ROCE of 12% is lower than 3 years ago, when the company reported a 22% ROCE. This makes us wonder if the business is facing new challenges.

ASX:JHX Past Revenue and Net Income, March 29th 2019

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. 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 James Hardie Industries.

What Are Current Liabilities, And How Do They Affect James Hardie Industries's ROCE?

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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 counter this, investors can check if a company has high current liabilities relative to total assets.

James Hardie Industries has total assets of US$4.0b and current liabilities of US$539m. Therefore its current liabilities are equivalent to approximately 14% of its total assets. Low current liabilities are not boosting the ROCE too much.

Our Take On James Hardie Industries's ROCE

With that in mind, James Hardie Industries's ROCE appears pretty good. 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.

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.