Today we’ll evaluate Louisiana-Pacific Corporation (NYSE:LPX) 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. Next, we’ll compare it to others in its industry. 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 metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. 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 Louisiana-Pacific:
0.28 = US$533m ÷ (US$2.6b – US$233m) (Based on the trailing twelve months to September 2018.)
Therefore, Louisiana-Pacific has an ROCE of 28%.
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Does Louisiana-Pacific Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Louisiana-Pacific’s ROCE is meaningfully better than the 9.8% average in the Forestry industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of the industry comparison, in absolute terms, Louisiana-Pacific’s ROCE currently appears to be excellent.
Louisiana-Pacific reported an ROCE of 28% — better than 3 years ago, when the company didn’t make a profit. That suggests the business has returned to profitability.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Louisiana-Pacific’s Current Liabilities And Their Impact On Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
Louisiana-Pacific has total assets of US$2.6b and current liabilities of US$233m. As a result, its current liabilities are equal to approximately 8.9% of its total assets. Louisiana-Pacific has low current liabilities, which have a negligible impact on its relatively good ROCE.
Our Take On Louisiana-Pacific’s ROCE
This should mark the company as worthy of further investigation. But note: Louisiana-Pacific may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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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 email@example.com.