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Why We Like Legacy Housing Corporation’s (NASDAQ:LEGH) 16% Return On Capital Employed

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Today we'll evaluate Legacy Housing Corporation (NASDAQ:LEGH) 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, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.

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

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. In brief, it is a useful tool, but it is not without drawbacks. 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'.

So, How Do We Calculate ROCE?

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 Legacy Housing:

0.16 = US$38m ÷ (US$284m - US$52m) (Based on the trailing twelve months to December 2019.)

Therefore, Legacy Housing has an ROCE of 16%.

View our latest analysis for Legacy Housing

Does Legacy Housing Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Legacy Housing's ROCE is meaningfully higher than the 12% average in the Consumer Durables industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from Legacy Housing's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

In our analysis, Legacy Housing's ROCE appears to be 16%, compared to 3 years ago, when its ROCE was 11%. This makes us think the business might be improving. The image below shows how Legacy Housing's ROCE compares to its industry, and you can click it to see more detail on its past growth.

NasdaqGS:LEGH Past Revenue and Net Income April 27th 2020
NasdaqGS:LEGH Past Revenue and Net Income April 27th 2020

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 only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Legacy Housing.

Legacy Housing'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 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Legacy Housing has current liabilities of US$52m and total assets of US$284m. Therefore its current liabilities are equivalent to approximately 18% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.

Our Take On Legacy Housing's ROCE

With that in mind, Legacy Housing's ROCE appears pretty good. There might be better investments than Legacy Housing out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.

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

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.

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. Thank you for reading.