Why Hilton Grand Vacations Inc.’s (NYSE:HGV) Return On Capital Employed Looks Uninspiring
Today we’ll evaluate Hilton Grand Vacations Inc. (NYSE:HGV) to determine whether it could have potential as an investment idea. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First of all, we’ll work out how to calculate ROCE. Second, we’ll look at its ROCE compared 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. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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?
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 Hilton Grand Vacations:
0.14 = US$345m ÷ (US$2.8b – US$277m) (Based on the trailing twelve months to September 2018.)
So, Hilton Grand Vacations has an ROCE of 14%.
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Does Hilton Grand Vacations Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Hilton Grand Vacations’s ROCE appears to be substantially greater than the 10% average in the Hospitality industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Hilton Grand Vacations compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Hilton Grand Vacations’s current ROCE of 14% is lower than 3 years ago, when the company reported a 21% ROCE. Therefore we wonder if the company is facing new headwinds.
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. 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 Hilton Grand Vacations.
Hilton Grand Vacations’s Current Liabilities And Their Impact On Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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.
Hilton Grand Vacations has total liabilities of US$277m and total assets of US$2.8b. Therefore its current liabilities are equivalent to approximately 9.8% of its total assets. In addition to low current liabilities (making a negligible impact on ROCE), Hilton Grand Vacations earns a sound return on capital employed.
What We Can Learn From Hilton Grand Vacations’s ROCE
If Hilton Grand Vacations can continue reinvesting in its business, it could be an attractive prospect. But note: Hilton Grand Vacations may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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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 editorial-team@simplywallst.com.
