Today we’ll evaluate Koppers Holdings Inc. (NYSE:KOP) to determine whether it could have potential as an investment idea. 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. Then we’ll compare its ROCE to similar companies. And finally, we’ll look at how its current liabilities are impacting 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. Ultimately, it is a useful but imperfect metric. 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 Koppers Holdings:
0.10 = US$138m ÷ (US$1.5b – US$283m) (Based on the trailing twelve months to September 2018.)
Therefore, Koppers Holdings has an ROCE of 10%.
Is Koppers Holdings’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. It appears that Koppers Holdings’s ROCE is fairly close to the Chemicals industry average of 12%. Separate from how Koppers Holdings stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.
In our analysis, Koppers Holdings’s ROCE appears to be 10%, compared to 3 years ago, when its ROCE was 6.6%. This makes us wonder if the company is improving.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Do Koppers Holdings’s Current Liabilities Skew Its 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Koppers Holdings has total liabilities of US$283m and total assets of US$1.5b. As a result, its current liabilities are equal to approximately 18% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
What We Can Learn From Koppers Holdings’s ROCE
That said, Koppers Holdings’s ROCE is mediocre, there may be more attractive investments around. Of course you might be able to find a better stock than Koppers Holdings. 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.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.