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Today we'll evaluate Simpson Manufacturing Co., Inc. (NYSE:SSD) to determine whether it could have potential as an investment idea. 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. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its 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?
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 Simpson Manufacturing:
0.19 = US$168m ÷ (US$1.0b - US$152m) (Based on the trailing twelve months to December 2018.)
So, Simpson Manufacturing has an ROCE of 19%.
Is Simpson Manufacturing's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Simpson Manufacturing's ROCE appears to be substantially greater than the 15% average in the Building industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Simpson Manufacturing compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Our data shows that Simpson Manufacturing currently has an ROCE of 19%, compared to its ROCE of 13% 3 years ago. This makes us wonder if the company is improving.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. 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 Simpson Manufacturing.
Do Simpson Manufacturing's Current Liabilities Skew Its ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that 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.
Simpson Manufacturing has total liabilities of US$152m and total assets of US$1.0b. As a result, its current liabilities are equal to approximately 15% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
The Bottom Line On Simpson Manufacturing's ROCE
Overall, Simpson Manufacturing has a decent ROCE and could be worthy of further research. You might be able to find a better buy than Simpson Manufacturing. 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).
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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.