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Stella-Jones Inc. (TSE:SJ) Earns Among The Best Returns In Its Industry

Simply Wall St

Today we'll evaluate Stella-Jones Inc. (TSE:SJ) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on its ROCE.

Return On Capital Employed (ROCE): What is it?

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. 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 Stella-Jones:

0.11 = CA$223m ÷ (CA$2.3b - CA$198m) (Based on the trailing twelve months to June 2019.)

So, Stella-Jones has an ROCE of 11%.

View our latest analysis for Stella-Jones

Is Stella-Jones's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Stella-Jones's ROCE is meaningfully higher than the 7.4% average in the Forestry 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. Independently of how Stella-Jones compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

Stella-Jones's current ROCE of 11% is lower than its ROCE in the past, which was 14%, 3 years ago. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how Stella-Jones's past growth compares to other companies.

TSX:SJ Past Revenue and Net Income, October 11th 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. ROCE is only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Stella-Jones.

Do Stella-Jones's Current Liabilities Skew Its 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Stella-Jones has total liabilities of CA$198m and total assets of CA$2.3b. Therefore its current liabilities are equivalent to approximately 8.6% of its total assets. Low current liabilities have only a minimal impact on Stella-Jones's ROCE, making its decent returns more credible.

The Bottom Line On Stella-Jones's ROCE

If Stella-Jones can continue reinvesting in its business, it could be an attractive prospect. Stella-Jones 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.

Stella-Jones is not the only stock that insiders are buying. 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.