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Is Kennametal Inc.’s (NYSE:KMT) 17% ROCE Any Good?

Simply Wall St

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Today we'll evaluate Kennametal Inc. (NYSE:KMT) 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 up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'

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 Kennametal:

0.17 = US$366m ÷ (US$2.5b - US$412m) (Based on the trailing twelve months to December 2018.)

So, Kennametal has an ROCE of 17%.

Check out our latest analysis for Kennametal

Does Kennametal Have A Good ROCE?

One way to assess ROCE is to compare similar companies. Kennametal's ROCE appears to be substantially greater than the 11% average in the Machinery industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how Kennametal compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

As we can see, Kennametal currently has an ROCE of 17% compared to its ROCE 3 years ago, which was 7.4%. This makes us wonder if the company is improving.

NYSE:KMT Past Revenue and Net Income, May 1st 2019

It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Kennametal.

How Kennametal's Current Liabilities Impact Its 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Kennametal has total liabilities of US$412m and total assets of US$2.5b. As a result, its current liabilities are equal to approximately 16% of its total assets. Low current liabilities are not boosting the ROCE too much.

Our Take On Kennametal's ROCE

This is good to see, and with a sound ROCE, Kennametal could be worth a closer look. Kennametal shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.

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.