Today we’ll look at Eagle Materials Inc. (NYSE:EXP) 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. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. 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.’
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 Eagle Materials:
0.14 = US$298m ÷ (US$2.4b – US$155m) (Based on the trailing twelve months to September 2018.)
So, Eagle Materials has an ROCE of 14%.
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Does Eagle Materials Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Eagle Materials’s ROCE is meaningfully higher than the 9.1% average in the Basic Materials industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how Eagle Materials compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during 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 Eagle Materials.
How Eagle Materials’s Current Liabilities Impact 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. 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.
Eagle Materials has total assets of US$2.4b and current liabilities of US$155m. Therefore its current liabilities are equivalent to approximately 6.5% of its total assets. In addition to low current liabilities (making a negligible impact on ROCE), Eagle Materials earns a sound return on capital employed.
Our Take On Eagle Materials’s ROCE
If it is able to keep this up, Eagle Materials could be attractive. Of course you might be able to find a better stock than Eagle Materials. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.