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Today we are going to look at Norfolk Southern Corporation (NYSE:NSC) 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.
First of all, we’ll work out how to calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
What is 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. 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. 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?
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 Norfolk Southern:
0.12 = US$4.0b ÷ (US$36b – US$2.6b) (Based on the trailing twelve months to December 2018.)
So, Norfolk Southern has an ROCE of 12%.
Is Norfolk Southern’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, Norfolk Southern’s ROCE appears to be around the 12% average of the Transportation industry. Regardless of where Norfolk Southern sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Our data shows that Norfolk Southern currently has an ROCE of 12%, compared to its ROCE of 9.2% 3 years ago. This makes us wonder if the company is improving.
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. 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 Norfolk Southern.
What Are Current Liabilities, And How Do They Affect Norfolk Southern’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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Norfolk Southern has total assets of US$36b and current liabilities of US$2.6b. Therefore its current liabilities are equivalent to approximately 7.1% of its total assets. In addition to low current liabilities (making a negligible impact on ROCE), Norfolk Southern earns a sound return on capital employed.
Our Take On Norfolk Southern’s ROCE
If it is able to keep this up, Norfolk Southern could be attractive. 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.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
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.