Today we'll look at Reliance Steel & Aluminum Co. (NYSE:RS) 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.
First up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding 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. Ultimately, it is a useful but imperfect metric. 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'.
So, How Do We Calculate ROCE?
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 Reliance Steel & Aluminum:
0.13 = US$950m ÷ (US$8.3b - US$761m) (Based on the trailing twelve months to June 2019.)
So, Reliance Steel & Aluminum has an ROCE of 13%.
Does Reliance Steel & Aluminum Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Reliance Steel & Aluminum's ROCE is meaningfully higher than the 8.9% average in the Metals and Mining 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 Reliance Steel & Aluminum'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, Reliance Steel & Aluminum's ROCE appears to be 13%, compared to 3 years ago, when its ROCE was 8.7%. This makes us think the business might be improving. You can click on the image below to see (in greater detail) how Reliance Steel & Aluminum's past growth compares to other companies.
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. Remember that most companies like Reliance Steel & Aluminum are cyclical businesses. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Reliance Steel & Aluminum.
What Are Current Liabilities, And How Do They Affect Reliance Steel & Aluminum'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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Reliance Steel & Aluminum has total liabilities of US$761m and total assets of US$8.3b. Therefore its current liabilities are equivalent to approximately 9.1% of its total assets. In addition to low current liabilities (making a negligible impact on ROCE), Reliance Steel & Aluminum earns a sound return on capital employed.
The Bottom Line On Reliance Steel & Aluminum's ROCE
If it is able to keep this up, Reliance Steel & Aluminum could be attractive. Reliance Steel & Aluminum 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 like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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 firstname.lastname@example.org. 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.