Today we are going to look at The Scotts Miracle-Gro Company (NYSE:SMG) to see whether it might be an attractive investment prospect. 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. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
Understanding Return On Capital Employed (ROCE)
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. Overall, it is a valuable metric that has its flaws. 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 Scotts Miracle-Gro:
0.18 = US$441m ÷ (US$3.5b - US$955m) (Based on the trailing twelve months to June 2019.)
Therefore, Scotts Miracle-Gro has an ROCE of 18%.
Does Scotts Miracle-Gro Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Scotts Miracle-Gro's ROCE is meaningfully higher than the 10% average in the Chemicals industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from Scotts Miracle-Gro's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
The image below shows how Scotts Miracle-Gro's ROCE compares to its industry, and you can click it to see more detail on its past growth.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. 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 Scotts Miracle-Gro's 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Scotts Miracle-Gro has total liabilities of US$955m and total assets of US$3.5b. Therefore its current liabilities are equivalent to approximately 28% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
Our Take On Scotts Miracle-Gro's ROCE
Overall, Scotts Miracle-Gro has a decent ROCE and could be worthy of further research. There might be better investments than Scotts Miracle-Gro 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 Scotts Miracle-Gro better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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If you spot an error that warrants correction, please contact the editor at email@example.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.