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Are O'Reilly Automotive, Inc.’s (NASDAQ:ORLY) High Returns Really That Great?

Simply Wall St

Today we'll evaluate O'Reilly Automotive, Inc. (NASDAQ:ORLY) to determine whether it could have potential as an investment idea. 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 of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting 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. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. 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 O'Reilly Automotive:

0.32 = US$1.9b ÷ (US$10b - US$4.4b) (Based on the trailing twelve months to June 2019.)

Therefore, O'Reilly Automotive has an ROCE of 32%.

View our latest analysis for O'Reilly Automotive

Is O'Reilly Automotive's ROCE Good?

One way to assess ROCE is to compare similar companies. In our analysis, O'Reilly Automotive's ROCE is meaningfully higher than the 10% average in the Specialty Retail industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of the industry comparison, in absolute terms, O'Reilly Automotive's ROCE currently appears to be excellent.

The image below shows how O'Reilly Automotive's ROCE compares to its industry, and you can click it to see more detail on its past growth.

NasdaqGS:ORLY Past Revenue and Net Income, October 18th 2019

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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for O'Reilly Automotive.

What Are Current Liabilities, And How Do They Affect O'Reilly Automotive's ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.

O'Reilly Automotive has total assets of US$10b and current liabilities of US$4.4b. Therefore its current liabilities are equivalent to approximately 43% of its total assets. A medium level of current liabilities boosts O'Reilly Automotive's ROCE somewhat.

What We Can Learn From O'Reilly Automotive's ROCE

Even so, it has a great ROCE, and could be an attractive prospect for further research. O'Reilly Automotive 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.

If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.

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 editorial-team@simplywallst.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.