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Here’s why Spectrum Brands Holdings, Inc.’s (NYSE:SPB) Returns On Capital Matters So Much

Simply Wall St

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Today we'll evaluate Spectrum Brands Holdings, Inc. (NYSE:SPB) to determine whether it could have potential as an investment idea. 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. Second, we'll look at its ROCE compared 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 metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. 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?

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 Spectrum Brands Holdings:

0.076 = US$343m ÷ (US$5.5b - US$992m) (Based on the trailing twelve months to March 2019.)

Therefore, Spectrum Brands Holdings has an ROCE of 7.6%.

View our latest analysis for Spectrum Brands Holdings

Does Spectrum Brands Holdings Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. We can see Spectrum Brands Holdings's ROCE is meaningfully below the Household Products industry average of 12%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how Spectrum Brands Holdings 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.

In our analysis, Spectrum Brands Holdings's ROCE appears to be 7.6%, compared to 3 years ago, when its ROCE was 5.0%. This makes us think the business might be improving. The image below shows how Spectrum Brands Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.

NYSE:SPB Past Revenue and Net Income, July 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Spectrum Brands Holdings.

Do Spectrum Brands Holdings'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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Spectrum Brands Holdings has total liabilities of US$992m and total assets of US$5.5b. Therefore its current liabilities are equivalent to approximately 18% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.

Our Take On Spectrum Brands Holdings's ROCE

If Spectrum Brands Holdings continues to earn an uninspiring ROCE, there may be better places to invest. 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.

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.