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Today we’ll look at Limoneira Company (NASDAQ:LMNR) and reflect on its potential as an investment. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First of all, we’ll work out how to calculate ROCE. Then we’ll compare its ROCE to similar companies. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
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. In brief, it is a useful tool, but it is not without drawbacks. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’
How Do You Calculate Return On Capital Employed?
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 Limoneira:
0.028 = US$11m ÷ (US$421m – US$27m) (Based on the trailing twelve months to October 2018.)
Therefore, Limoneira has an ROCE of 2.8%.
Is Limoneira’s ROCE Good?
One way to assess ROCE is to compare similar companies. In this analysis, Limoneira’s ROCE appears meaningfully below the 8.7% average reported by the Food industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Regardless of how Limoneira stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). Readers may wish to look for more rewarding investments.
In our analysis, Limoneira’s ROCE appears to be 2.8%, compared to 3 years ago, when its ROCE was 1.8%. This makes us think about whether the company has been reinvesting shrewdly.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Limoneira.
What Are Current Liabilities, And How Do They Affect Limoneira’s 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.
Limoneira has total liabilities of US$27m and total assets of US$421m. Therefore its current liabilities are equivalent to approximately 6.4% of its total assets. Limoneira has a low level of current liabilities, which have a negligible impact on its already low ROCE.
Our Take On Limoneira’s ROCE
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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.