Today we'll look at Rexnord Corporation (NYSE:RXN) 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, 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.
What is Return On Capital Employed (ROCE)?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed 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?
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 Rexnord:
0.11 = US$330m ÷ (US$3.3b - US$354m) (Based on the trailing twelve months to June 2019.)
Therefore, Rexnord has an ROCE of 11%.
Does Rexnord Have A Good ROCE?
One way to assess ROCE is to compare similar companies. It appears that Rexnord's ROCE is fairly close to the Machinery industry average of 11%. Regardless of where Rexnord sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
We can see that, Rexnord currently has an ROCE of 11% compared to its ROCE 3 years ago, which was 6.9%. This makes us think about whether the company has been reinvesting shrewdly. The image below shows how Rexnord's ROCE compares to its industry, and you can click it to see more detail on its past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. 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, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Rexnord.
Do Rexnord'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. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Rexnord has total assets of US$3.3b and current liabilities of US$354m. Therefore its current liabilities are equivalent to approximately 11% of its total assets. Low current liabilities are not boosting the ROCE too much.
What We Can Learn From Rexnord's ROCE
With that in mind, Rexnord's ROCE appears pretty good. Rexnord shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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. Thank you for reading.