U.S. Markets open in 9 hrs 25 mins

Are PulteGroup, Inc.’s (NYSE:PHM) High Returns Really That Great?

Simply Wall St

Today we are going to look at PulteGroup, Inc. (NYSE:PHM) to see whether it might be an attractive investment prospect. 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. Then we'll compare its ROCE to similar companies. 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. Generally speaking a higher ROCE is better. 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?

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 PulteGroup:

0.16 = US$1.3b ÷ (US$10b - US$1.9b) (Based on the trailing twelve months to June 2019.)

So, PulteGroup has an ROCE of 16%.

Check out our latest analysis for PulteGroup

Is PulteGroup's ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. In our analysis, PulteGroup's ROCE is meaningfully higher than the 13% average in the Consumer Durables industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Separate from PulteGroup's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

Our data shows that PulteGroup currently has an ROCE of 16%, compared to its ROCE of 12% 3 years ago. This makes us wonder if the company is improving. The image below shows how PulteGroup's ROCE compares to its industry, and you can click it to see more detail on its past growth.

NYSE:PHM Past Revenue and Net Income, August 10th 2019

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for PulteGroup.

How PulteGroup's Current Liabilities Impact Its ROCE

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counter this, investors can check if a company has high current liabilities relative to total assets.

PulteGroup has total assets of US$10b and current liabilities of US$1.9b. Therefore its current liabilities are equivalent to approximately 18% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.

What We Can Learn From PulteGroup's ROCE

With that in mind, PulteGroup's ROCE appears pretty good. PulteGroup 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.

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.