Today we’ll look at The Toro Company (NYSE:TTC) and reflect on its potential as an investment. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
Firstly, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. And finally, we’ll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. 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.’
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 Toro:
0.36 = US$373m ÷ (US$1.6b – US$533m) (Based on the trailing twelve months to October 2018.)
Therefore, Toro has an ROCE of 36%.
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Is Toro’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Toro’s ROCE appears to be substantially greater than the 12% average in the Machinery 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. Putting aside its position relative to its industry for now, in absolute terms, Toro’s ROCE is currently very good.
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. 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 Toro.
How Toro’s Current Liabilities Impact 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 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.
Toro has total liabilities of US$533m and total assets of US$1.6b. As a result, its current liabilities are equal to approximately 34% of its total assets. Toro’s ROCE is boosted somewhat by its middling amount of current liabilities.
What We Can Learn From Toro’s ROCE
Still, it has a high ROCE, and may be an interesting prospect for further research. Of course you might be able to find a better stock than Toro. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like Toro better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.