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How Do McGrath RentCorp’s (NASDAQ:MGRC) Returns Compare To Its Industry?

Asher Wright

Today we are going to look at McGrath RentCorp (NASDAQ:MGRC) to see whether it might be an attractive investment prospect. 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. Next, we’ll compare it to others in its industry. And finally, we’ll look at how its current liabilities are impacting its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. 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?

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 McGrath RentCorp:

0.10 = US$96m ÷ (US$1.2b – US$92m) (Based on the trailing twelve months to September 2018.)

Therefore, McGrath RentCorp has an ROCE of 10.0%.

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Is McGrath RentCorp’s ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. It appears that McGrath RentCorp’s ROCE is fairly close to the Commercial Services industry average of 11%. Setting aside the industry comparison for now, McGrath RentCorp’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.

As we can see, McGrath RentCorp currently has an ROCE of 10.0% compared to its ROCE 3 years ago, which was 7.6%. This makes us think the business might be improving.

NasdaqGS:MGRC Last Perf January 23rd 19

When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Do McGrath RentCorp’s Current Liabilities Skew Its ROCE?

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counter this, investors can check if a company has high current liabilities relative to total assets.

McGrath RentCorp has total assets of US$1.2b and current liabilities of US$92m. Therefore its current liabilities are equivalent to approximately 7.7% of its total assets. With low levels of current liabilities, at least McGrath RentCorp’s mediocre ROCE is not unduly boosted.

What We Can Learn From McGrath RentCorp’s ROCE

If performance improves, then McGrath RentCorp may be an OK investment, especially at the right valuation. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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 editorial-team@simplywallst.com.