Today we'll evaluate The Western Union Company (NYSE:WU) to determine whether it could have potential as an investment idea. 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, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. 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. All else being equal, a better business will have a higher ROCE. 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?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for Western Union:
0.29 = US$1.1b ÷ (US$8.8b - US$5.1b) (Based on the trailing twelve months to September 2019.)
So, Western Union has an ROCE of 29%.
Is Western Union's ROCE Good?
One way to assess ROCE is to compare similar companies. In our analysis, Western Union's ROCE is meaningfully higher than the 11% average in the IT 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. Setting aside the comparison to its industry for a moment, Western Union's ROCE in absolute terms currently looks quite high.
Our data shows that Western Union currently has an ROCE of 29%, compared to its ROCE of 22% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly. You can see in the image below how Western Union's ROCE compares to its industry. Click to see more on past growth.
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 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 Western Union.
What Are Current Liabilities, And How Do They Affect Western Union's ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Western Union has total liabilities of US$5.1b and total assets of US$8.8b. As a result, its current liabilities are equal to approximately 58% of its total assets. Western Union boasts an attractive ROCE, even after considering the boost from high current liabilities.
Our Take On Western Union's ROCE
So to us, the company is potentially worth investigating further. Western Union 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.
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 firstname.lastname@example.org. 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.