Today we are going to look at W.W. Grainger, Inc. (NYSE:GWW) to see whether it might be an attractive investment prospect. 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.
First, we'll go over how we 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 measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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 W.W. Grainger:
0.31 = US$1.4b ÷ (US$6.0b - US$1.5b) (Based on the trailing twelve months to June 2019.)
So, W.W. Grainger has an ROCE of 31%.
Is W.W. Grainger's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. W.W. Grainger's ROCE appears to be substantially greater than the 8.0% average in the Trade Distributors industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of the industry comparison, in absolute terms, W.W. Grainger's ROCE currently appears to be excellent.
You can see in the image below how W.W. Grainger's ROCE compares to its industry. Click to see more on 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
How W.W. Grainger'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.
W.W. Grainger has total assets of US$6.0b and current liabilities of US$1.5b. Therefore its current liabilities are equivalent to approximately 24% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.
Our Take On W.W. Grainger's ROCE
This is good to see, and with such a high ROCE, W.W. Grainger may be worth a closer look. There might be better investments than W.W. Grainger out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
I will like W.W. Grainger better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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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.