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Why We Like The Sherwin-Williams Company’s (NYSE:SHW) 13% Return On Capital Employed

Simply Wall St

Today we are going to look at The Sherwin-Williams Company (NYSE:SHW) to see whether it might be an attractive investment prospect. 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 of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. 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'.

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 Sherwin-Williams:

0.13 = US$2.2b ÷ (US$21b - US$4.9b) (Based on the trailing twelve months to September 2019.)

So, Sherwin-Williams has an ROCE of 13%.

View our latest analysis for Sherwin-Williams

Does Sherwin-Williams Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Sherwin-Williams's ROCE is meaningfully higher than the 9.9% average in the Chemicals industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Sherwin-Williams compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

Sherwin-Williams's current ROCE of 13% is lower than its ROCE in the past, which was 40%, 3 years ago. So investors might consider if it has had issues recently. You can click on the image below to see (in greater detail) how Sherwin-Williams's past growth compares to other companies.

NYSE:SHW Past Revenue and Net Income, November 14th 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Sherwin-Williams.

Sherwin-Williams'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 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Sherwin-Williams has total liabilities of US$4.9b and total assets of US$21b. As a result, its current liabilities are equal to approximately 23% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.

What We Can Learn From Sherwin-Williams's ROCE

Overall, Sherwin-Williams has a decent ROCE and could be worthy of further research. Sherwin-Williams shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.

If you are like me, then you will not want to miss this free list of growing companies that insiders are 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. Thank you for reading.