Today we are going to look at M.D.C. Holdings, Inc. (NYSE:MDC) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting 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. 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'.
How Do You Calculate Return On Capital Employed?
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 M.D.C. Holdings:
0.12 = US$302m ÷ (US$3.3b - US$769m) (Based on the trailing twelve months to December 2019.)
So, M.D.C. Holdings has an ROCE of 12%.
Does M.D.C. Holdings Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. It appears that M.D.C. Holdings's ROCE is fairly close to the Consumer Durables industry average of 12%. Independently of how M.D.C. Holdings compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
In our analysis, M.D.C. Holdings's ROCE appears to be 12%, compared to 3 years ago, when its ROCE was 7.3%. This makes us think the business might be improving. The image below shows how M.D.C. Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for M.D.C. Holdings.
M.D.C. Holdings's Current Liabilities And Their Impact On 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. 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.
M.D.C. Holdings has total assets of US$3.3b and current liabilities of US$769m. As a result, its current liabilities are equal to approximately 23% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
The Bottom Line On M.D.C. Holdings's ROCE
Overall, M.D.C. Holdings has a decent ROCE and could be worthy of further research. M.D.C. Holdings 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.
I will like M.D.C. Holdings better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
If you spot an error that warrants correction, please contact the editor at email@example.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.
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