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Should You Like O’Reilly Automotive, Inc.’s (NASDAQ:ORLY) High Return On Capital Employed?

Tammie Asher

Today we’ll look at O’Reilly Automotive, Inc. (NASDAQ:ORLY) and reflect on its potential as an investment. 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. Then we’ll determine how its current liabilities are affecting 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. 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 O’Reilly Automotive:

0.45 = US$1.7b ÷ (US$7.9b – US$3.9b) (Based on the trailing twelve months to September 2018.)

So, O’Reilly Automotive has an ROCE of 45%.

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Does O’Reilly Automotive Have A Good ROCE?

One way to assess ROCE is to compare similar companies. Using our data, we find that O’Reilly Automotive’s ROCE is meaningfully better than the 13% average in the Specialty Retail 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, O’Reilly Automotive’s ROCE currently appears to be excellent.

NASDAQGS:ORLY Last Perf January 29th 19

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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 only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

How O’Reilly Automotive’s Current Liabilities Impact 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 counter this, investors can check if a company has high current liabilities relative to total assets.

O’Reilly Automotive has total liabilities of US$3.9b and total assets of US$7.9b. Therefore its current liabilities are equivalent to approximately 49% of its total assets. O’Reilly Automotive’s ROCE is boosted somewhat by its middling amount of current liabilities.

Our Take On O’Reilly Automotive’s ROCE

Despite this, it reports a high ROCE, and may be worth investigating further. You might be able to find a better buy than O’Reilly Automotive. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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.