Today we are going to look at The Sherwin-Williams Company (NYSE:SHW) to see whether it might be an attractive investment prospect. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. 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. All else being equal, a better business will have a higher ROCE. 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 Sherwin-Williams:
0.16 = US$2.5b ÷ (US$21b - US$5.2b) (Based on the trailing twelve months to March 2020.)
Therefore, Sherwin-Williams has an ROCE of 16%.
Does Sherwin-Williams Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Sherwin-Williams's ROCE appears to be substantially greater than the 9.7% average in the Chemicals industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how Sherwin-Williams compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
We can see that, Sherwin-Williams currently has an ROCE of 16%, less than the 44% it reported 3 years ago. So investors might consider if it has had issues recently. The image below shows how Sherwin-Williams's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Sherwin-Williams.
What Are Current Liabilities, And How Do They Affect Sherwin-Williams's 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Sherwin-Williams has current liabilities of US$5.2b and total assets of US$21b. Therefore its current liabilities are equivalent to approximately 25% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
Our Take On Sherwin-Williams's ROCE
With that in mind, Sherwin-Williams's ROCE appears pretty good. Sherwin-Williams looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.