Today we’ll evaluate Fortune Brands Home & Security, Inc. (NYSE:FBHS) to determine whether it could have potential as an investment idea. 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.
Firstly, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. 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 Fortune Brands Home & Security:
0.15 = US$740m ÷ (US$6.3b – US$1.4b) (Based on the trailing twelve months to September 2019.)
Therefore, Fortune Brands Home & Security has an ROCE of 15%.
See our latest analysis for Fortune Brands Home & Security
Is Fortune Brands Home & Security’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, Fortune Brands Home & Security’s ROCE appears to be around the 13% average of the Building industry. Separate from Fortune Brands Home & Security’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 Fortune Brands Home & Security’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. 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, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for Fortune Brands Home & Security.
Do Fortune Brands Home & Security’s Current Liabilities Skew 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.
Fortune Brands Home & Security has total assets of US$6.3b and current liabilities of US$1.4b. Therefore its current liabilities are equivalent to approximately 22% of its total assets. Low current liabilities are not boosting the ROCE too much.
Our Take On Fortune Brands Home & Security’s ROCE
With that in mind, Fortune Brands Home & Security’s ROCE appears pretty good. There might be better investments than Fortune Brands Home & Security 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 Fortune Brands Home & Security better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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.
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