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Is Toll Brothers, Inc. (NYSE:TOL) Better Than Average At Deploying Capital?

Simply Wall St

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Today we are going to look at Toll Brothers, Inc. (NYSE:TOL) 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.

First of all, we'll work out how to 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.

Understanding Return On Capital Employed (ROCE)

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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'.

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 Toll Brothers:

0.099 = US$886m ÷ (US$10b - US$1.3b) (Based on the trailing twelve months to April 2019.)

So, Toll Brothers has an ROCE of 9.9%.

See our latest analysis for Toll Brothers

Is Toll Brothers's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Toll Brothers's ROCE appears to be around the 11% average of the Consumer Durables industry. Aside from the industry comparison, Toll Brothers's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.

In our analysis, Toll Brothers's ROCE appears to be 9.9%, compared to 3 years ago, when its ROCE was 6.6%. This makes us think about whether the company has been reinvesting shrewdly.

NYSE:TOL Past Revenue and Net Income, June 17th 2019

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

How Toll Brothers's Current Liabilities Impact Its 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 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Toll Brothers has total liabilities of US$1.3b and total assets of US$10b. Therefore its current liabilities are equivalent to approximately 13% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.

What We Can Learn From Toll Brothers's ROCE

With that in mind, we're not overly impressed with Toll Brothers's ROCE, so it may not be the most appealing prospect. You might be able to find a better investment than Toll Brothers. 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.

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.