Today we’ll look at W.W. Grainger, Inc. (NYSE:GWW) and reflect on its potential as an investment. 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.
What is 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.’
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 W.W. Grainger:
0.31 = US$1.4b ÷ (US$6.0b – US$1.5b) (Based on the trailing twelve months to June 2019.)
Therefore, W.W. Grainger has an ROCE of 31%.
Is W.W. Grainger’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that W.W. Grainger’s ROCE is meaningfully better than the 9.0% average in the Trade Distributors industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Putting aside its position relative to its industry for now, in absolute terms, W.W. Grainger’s ROCE is currently very good.
When considering this metric, keep in mind that it is backwards looking, and 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, after all, simply a snap shot of a single year. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
How W.W. Grainger’s Current Liabilities Impact Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
W.W. Grainger has total assets of US$6.0b and current liabilities of US$1.5b. As a result, its current liabilities are equal to approximately 24% of its total assets. This is quite a low level of current liabilities which would not greatly boost the already high ROCE.
Our Take On W.W. Grainger’s ROCE
Low current liabilities and high ROCE is a good combination, making W.W. Grainger look quite interesting. There might be better investments than W.W. Grainger 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.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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