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Here’s why Kraton Corporation’s (NYSE:KRA) Returns On Capital Matters So Much

Simply Wall St

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Today we'll look at Kraton Corporation (NYSE:KRA) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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?

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 Kraton:

0.084 = US$212m ÷ (US$3.0b - US$426m) (Based on the trailing twelve months to March 2019.)

Therefore, Kraton has an ROCE of 8.4%.

View our latest analysis for Kraton

Does Kraton Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. Using our data, Kraton's ROCE appears to be significantly below the 11% average in the Chemicals 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 Kraton stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.

As we can see, Kraton currently has an ROCE of 8.4% compared to its ROCE 3 years ago, which was 1.8%. This makes us think the business might be improving.

NYSE:KRA Past Revenue and Net Income, June 7th 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

What Are Current Liabilities, And How Do They Affect Kraton's 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.

Kraton has total assets of US$3.0b and current liabilities of US$426m. As a result, its current liabilities are equal to approximately 14% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.

The Bottom Line On Kraton's ROCE

That said, Kraton's ROCE is mediocre, there may be more attractive investments around. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio 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).

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.