Today we'll look at Summit Materials, Inc. (NYSE:SUM) and reflect on its potential as an investment. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect 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. In general, businesses with a higher ROCE are usually better quality. 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?
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 Summit Materials:
0.044 = US$162m ÷ (US$4.0b - US$305m) (Based on the trailing twelve months to June 2019.)
Therefore, Summit Materials has an ROCE of 4.4%.
Does Summit Materials Have A Good ROCE?
One way to assess ROCE is to compare similar companies. In this analysis, Summit Materials's ROCE appears meaningfully below the 8.9% average reported by the Basic Materials industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Putting aside Summit Materials's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. Readers may wish to look for more rewarding investments.
We can see that, Summit Materials currently has an ROCE of 4.4%, less than the 7.1% it reported 3 years ago. So investors might consider if it has had issues recently. The image below shows how Summit Materials's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Summit Materials.
What Are Current Liabilities, And How Do They Affect Summit Materials'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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Summit Materials has total assets of US$4.0b and current liabilities of US$305m. Therefore its current liabilities are equivalent to approximately 7.7% of its total assets. Summit Materials has very few current liabilities, which have a minimal effect on its already low ROCE.
Our Take On Summit Materials's ROCE
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.