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Today we are going to look at Quaker Chemical Corporation (NYSE:KWR) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First up, we'll look at what ROCE is and how we calculate it. 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 is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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 Quaker Chemical:
0.18 = US$101m ÷ (US$709m - US$148m) (Based on the trailing twelve months to March 2019.)
Therefore, Quaker Chemical has an ROCE of 18%.
Is Quaker Chemical's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Quaker Chemical's ROCE is meaningfully higher than the 10% average in the Chemicals industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from Quaker Chemical's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
In our analysis, Quaker Chemical's ROCE appears to be 18%, compared to 3 years ago, when its ROCE was 14%. This makes us think the business might be improving. You can see in the image below how Quaker Chemical's ROCE compares to its industry. Click to see more on 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 only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Quaker Chemical.
Do Quaker Chemical's Current Liabilities Skew Its 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Quaker Chemical has total liabilities of US$148m and total assets of US$709m. As a result, its current liabilities are equal to approximately 21% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
Our Take On Quaker Chemical's ROCE
With that in mind, Quaker Chemical's ROCE appears pretty good. There might be better investments than Quaker Chemical out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
I will like Quaker Chemical better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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 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.