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Today we'll evaluate Kronos Worldwide, Inc. (NYSE:KRO) 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.
Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. 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. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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 Kronos Worldwide:
0.18 = US$305m ÷ (US$1.9b - US$233m) (Based on the trailing twelve months to December 2018.)
So, Kronos Worldwide has an ROCE of 18%.
Is Kronos Worldwide's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Kronos Worldwide's ROCE appears to be substantially greater than the 12% average in the Chemicals industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Kronos Worldwide compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Our data shows that Kronos Worldwide currently has an ROCE of 18%, compared to its ROCE of 2.0% 3 years ago. This makes us wonder if the company is improving.
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 only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Do Kronos Worldwide's Current Liabilities Skew 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. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Kronos Worldwide has total assets of US$1.9b and current liabilities of US$233m. As a result, its current liabilities are equal to approximately 12% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
What We Can Learn From Kronos Worldwide's ROCE
With that in mind, Kronos Worldwide's ROCE appears pretty good. Kronos Worldwide looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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 firstname.lastname@example.org. 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.