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Here’s why ABM Industries Incorporated’s (NYSE:ABM) Returns On Capital Matters So Much

Simply Wall St

Today we are going to look at ABM Industries Incorporated (NYSE:ABM) 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 of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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 ABM Industries:

0.07 = US$202m ÷ (US$3.7b - US$877m) (Based on the trailing twelve months to July 2019.)

So, ABM Industries has an ROCE of 7.0%.

View our latest analysis for ABM Industries

Is ABM Industries's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. We can see ABM Industries's ROCE is meaningfully below the Commercial Services industry average of 9.4%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Aside from the industry comparison, ABM Industries's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.

You can click on the image below to see (in greater detail) how ABM Industries's past growth compares to other companies.

NYSE:ABM Past Revenue and Net Income, December 3rd 2019
NYSE:ABM Past Revenue and Net Income, December 3rd 2019

When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for ABM Industries.

ABM Industries'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. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.

ABM Industries has total assets of US$3.7b and current liabilities of US$877m. Therefore its current liabilities are equivalent to approximately 23% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.

What We Can Learn From ABM Industries's ROCE

That said, ABM Industries's ROCE is mediocre, there may be more attractive investments around. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.

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.

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. Thank you for reading.