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Why Multi-Color Corporation’s (NASDAQ:LABL) Return On Capital Employed Might Be A Concern

Peter Morris

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Today we’ll evaluate Multi-Color Corporation (NASDAQ:LABL) 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 up, we’ll look at what ROCE is and how we calculate it. Second, we’ll look at its ROCE compared to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.

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

ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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.’

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 Multi-Color:

0.082 = US$161m ÷ (US$2.7b – US$285m) (Based on the trailing twelve months to December 2018.)

So, Multi-Color has an ROCE of 8.2%.

View our latest analysis for Multi-Color

Does Multi-Color Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. We can see Multi-Color’s ROCE is meaningfully below the Commercial Services industry average of 11%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how Multi-Color 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, Multi-Color currently has an ROCE of 8.2%, less than the 11% it reported 3 years ago. This makes us wonder if the business is facing new challenges.

NasdaqGS:LABL Past Revenue and Net Income, February 19th 2019

When considering this metric, keep in mind that it is backwards looking, and 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.

Do Multi-Color’s Current Liabilities Skew Its ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Multi-Color has total assets of US$2.7b and current liabilities of US$285m. Therefore its current liabilities are equivalent to approximately 10% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.

The Bottom Line On Multi-Color’s ROCE

With that in mind, we’re not overly impressed with Multi-Color’s ROCE, so it may not be the most appealing prospect. 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.

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

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. On rare occasion, data errors may occur. Thank you for reading.