Today we'll look at Trinity Industries, Inc. (NYSE:TRN) and reflect on its potential as an investment. 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.
Firstly, 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.
Return On Capital Employed (ROCE): What is it?
ROCE measures the 'return' (pre-tax profit) a company generates from 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?
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 Trinity Industries:
0.037 = US$296m (US$8.6b - US$564m) (Based on the trailing twelve months to June 2019.)
Therefore, Trinity Industries has an ROCE of 3.7%.
Is Trinity Industries's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, Trinity Industries's ROCE appears meaningfully below the 11% average reported by the Machinery industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Independently of how Trinity Industries compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.7% available in government bonds. There are potentially more appealing investments elsewhere.
Trinity Industries's current ROCE of 3.7% is lower than 3 years ago, when the company reported a 12% ROCE. So investors might consider if it has had issues recently. You can see in the image below how Trinity Industries's ROCE compares to its industry. Click to see more on past growth.
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. 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 Trinity Industries.
Trinity Industries's Current Liabilities And Their Impact On 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. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Trinity Industries has total assets of US$8.6b and current liabilities of US$564m. As a result, its current liabilities are equal to approximately 6.6% of its total assets. Trinity Industries has very few current liabilities, which have a minimal effect on its already low ROCE.
What We Can Learn From Trinity Industries's ROCE
Nevertheless, there are potentially more attractive companies to invest in. You might be able to find a better investment than Trinity Industries. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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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.