Today we’ll look at Knoll, Inc. (NYSE:KNL) and reflect on its potential as an investment. 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.
Firstly, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
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. 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?
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 Knoll:
0.13 = US$123m ÷ (US$1.2b – US$273m) (Based on the trailing twelve months to December 2018.)
So, Knoll has an ROCE of 13%.
Does Knoll Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Knoll’s ROCE appears to be substantially greater than the 10% average in the Commercial Services industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Separate from Knoll’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Knoll’s current ROCE of 13% is lower than 3 years ago, when the company reported a 18% ROCE. So investors might consider if it has had issues recently.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for Knoll.
Knoll’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. 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.
Knoll has total assets of US$1.2b and current liabilities of US$273m. Therefore its current liabilities are equivalent to approximately 22% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
What We Can Learn From Knoll’s ROCE
This is good to see, and with a sound ROCE, Knoll could be worth a closer look. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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