Today we'll look at Booz Allen Hamilton Holding Corporation (NYSE:BAH) and reflect on its potential as an investment. 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 up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. 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'.
How Do You Calculate Return On Capital Employed?
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 Booz Allen Hamilton Holding:
0.19 = US$613m ÷ (US$4.5b - US$1.2b) (Based on the trailing twelve months to June 2019.)
Therefore, Booz Allen Hamilton Holding has an ROCE of 19%.
Does Booz Allen Hamilton Holding Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that Booz Allen Hamilton Holding's ROCE is meaningfully better than the 10% average in the IT industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how Booz Allen Hamilton Holding compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
The image below shows how Booz Allen Hamilton Holding's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Booz Allen Hamilton Holding.
Do Booz Allen Hamilton Holding's Current Liabilities Skew Its ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Booz Allen Hamilton Holding has total liabilities of US$1.2b and total assets of US$4.5b. Therefore its current liabilities are equivalent to approximately 27% of its total assets. Low current liabilities are not boosting the ROCE too much.
The Bottom Line On Booz Allen Hamilton Holding's ROCE
With that in mind, Booz Allen Hamilton Holding's ROCE appears pretty good. Booz Allen Hamilton Holding shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
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.