Today we'll look at Kaufman & Broad S.A. (EPA:KOF) 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.
Firstly, 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 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?
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 Kaufman & Broad:
0.22 = €124m ÷ (€1.6b - €988m) (Based on the trailing twelve months to February 2020.)
So, Kaufman & Broad has an ROCE of 22%.
Does Kaufman & Broad Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Kaufman & Broad's ROCE is meaningfully higher than the 11% average in the Consumer Durables 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. Putting aside its position relative to its industry for now, in absolute terms, Kaufman & Broad's ROCE is currently very good.
You can click on the image below to see (in greater detail) how Kaufman & Broad's past growth compares to other companies.
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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Kaufman & Broad.
Do Kaufman & Broad's Current Liabilities Skew Its ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Kaufman & Broad has total assets of €1.6b and current liabilities of €988m. As a result, its current liabilities are equal to approximately 64% of its total assets. Kaufman & Broad boasts an attractive ROCE, even after considering the boost from high current liabilities.
Our Take On Kaufman & Broad's ROCE
So to us, the company is potentially worth investigating further. There might be better investments than Kaufman & Broad out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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