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Why You Should Care About Darling Ingredients Inc.’s (NYSE:DAR) Low Return On Capital

Simply Wall St

Today we'll look at Darling Ingredients Inc. (NYSE:DAR) 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 of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. 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?

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 Darling Ingredients:

0.02 = US$87m ÷ (US$4.9b - US$596m) (Based on the trailing twelve months to September 2019.)

Therefore, Darling Ingredients has an ROCE of 2.0%.

Check out our latest analysis for Darling Ingredients

Is Darling Ingredients's ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. We can see Darling Ingredients's ROCE is meaningfully below the Food industry average of 8.7%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Putting aside Darling Ingredients's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. Readers may wish to look for more rewarding investments.

Darling Ingredients's current ROCE of 2.0% is lower than its ROCE in the past, which was 3.5%, 3 years ago. Therefore we wonder if the company is facing new headwinds. You can see in the image below how Darling Ingredients's ROCE compares to its industry. Click to see more on past growth.

NYSE:DAR Past Revenue and Net Income, February 24th 2020

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 only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Darling Ingredients's Current Liabilities And Their Impact On 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.

Darling Ingredients has current liabilities of US$596m and total assets of US$4.9b. Therefore its current liabilities are equivalent to approximately 12% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.

What We Can Learn From Darling Ingredients's ROCE

Darling Ingredients has a poor ROCE, and there may be better investment prospects out there. Of course, you might also be able to find a better stock than Darling Ingredients. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.