Today we are going to look at M.D.C. Holdings, Inc. (NYSE:MDC) to see whether it might be an attractive investment prospect. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First up, we'll look at what ROCE is and how we calculate it. 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. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'
So, How Do We Calculate ROCE?
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 M.D.C. Holdings:
0.12 = US$285m ÷ (US$3.1b - US$638m) (Based on the trailing twelve months to June 2019.)
Therefore, M.D.C. Holdings has an ROCE of 12%.
Is M.D.C. Holdings's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. We can see M.D.C. Holdings's ROCE is around the 12% average reported by the Consumer Durables industry. Regardless of where M.D.C. Holdings sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
In our analysis, M.D.C. Holdings's ROCE appears to be 12%, compared to 3 years ago, when its ROCE was 5.8%. This makes us wonder if the company is improving. The image below shows how M.D.C. Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for M.D.C. Holdings.
Do M.D.C. Holdings'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. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.
M.D.C. Holdings has total assets of US$3.1b and current liabilities of US$638m. As a result, its current liabilities are equal to approximately 21% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
What We Can Learn From M.D.C. Holdings's ROCE
Overall, M.D.C. Holdings has a decent ROCE and could be worthy of further research. M.D.C. Holdings 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.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.