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Why You Should Care About Taylor Morrison Home Corporation’s (NYSE:TMHC) Low Return On Capital

Simply Wall St

Today we'll evaluate Taylor Morrison Home Corporation (NYSE:TMHC) 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 of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.

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

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its 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. 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 Taylor Morrison Home:

0.082 = US$368m ÷ (US$5.2b - US$668m) (Based on the trailing twelve months to June 2019.)

Therefore, Taylor Morrison Home has an ROCE of 8.2%.

Check out our latest analysis for Taylor Morrison Home

Does Taylor Morrison Home Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Taylor Morrison Home's ROCE appears to be significantly below the 12% average in the Consumer Durables industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Separate from how Taylor Morrison Home stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.

You can see in the image below how Taylor Morrison Home's ROCE compares to its industry. Click to see more on past growth.

NYSE:TMHC Past Revenue and Net Income, September 20th 2019

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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Taylor Morrison Home.

Do Taylor Morrison Home'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 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.

Taylor Morrison Home has total liabilities of US$668m and total assets of US$5.2b. As a result, its current liabilities are equal to approximately 13% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.

The Bottom Line On Taylor Morrison Home's ROCE

That said, Taylor Morrison Home's ROCE is mediocre, there may be more attractive investments around. Of course, you might also be able to find a better stock than Taylor Morrison Home. So you may wish to see this free collection of other companies that have grown earnings strongly.

I will like Taylor Morrison Home better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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 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. Thank you for reading.