Today we'll evaluate W.W. Grainger, Inc. (NYSE:GWW) 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.
Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect 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. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. 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:
0.32 = US$1.4b ÷ (US$5.9b - US$1.6b) (Based on the trailing twelve months to September 2019.)
Therefore, W.W. Grainger has an ROCE of 32%.
Does W.W. Grainger Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that W.W. Grainger's ROCE is meaningfully better than the 9.4% average in the Trade Distributors industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Setting aside the comparison to its industry for a moment, W.W. Grainger's ROCE in absolute terms currently looks quite high.
You can click on the image below to see (in greater detail) how W.W. Grainger's past growth compares to other companies.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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 W.W. Grainger.
W.W. Grainger's Current Liabilities And Their Impact On Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
W.W. Grainger has total assets of US$5.9b and current liabilities of US$1.6b. Therefore its current liabilities are equivalent to approximately 27% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.
What We Can Learn From W.W. Grainger's ROCE
Low current liabilities and high ROCE is a good combination, making W.W. Grainger look quite interesting. W.W. Grainger looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.
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