U.S. Markets closed

Shareholders Should Look Hard At KB Home’s (NYSE:KBH) 8.7%Return On Capital

Simply Wall St

Today we'll look at KB Home (NYSE:KBH) and reflect on its potential as an investment. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

First, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. 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 KB Home:

0.087 = US$333m ÷ (US$5.0b - US$1.2b) (Based on the trailing twelve months to August 2019.)

So, KB Home has an ROCE of 8.7%.

View our latest analysis for KB Home

Does KB Home Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, KB Home's ROCE appears to be significantly below the 12% average in the Consumer Durables industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Aside from the industry comparison, KB Home's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.

Our data shows that KB Home currently has an ROCE of 8.7%, compared to its ROCE of 4.6% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly. The image below shows how KB Home's ROCE compares to its industry, and you can click it to see more detail on its past growth.

NYSE:KBH Past Revenue and Net Income, October 14th 2019

When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

KB Home's Current Liabilities And Their Impact On 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 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.

KB Home has total liabilities of US$1.2b and total assets of US$5.0b. As a result, its current liabilities are equal to approximately 24% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.

Our Take On KB Home's ROCE

If KB Home continues to earn an uninspiring ROCE, there may be better places to invest. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

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.