Today we’ll evaluate Leggett & Platt, Incorporated (NYSE:LEG) 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.
First of all, we’ll work out how to calculate ROCE. Then we’ll compare its ROCE to similar companies. And finally, we’ll look at how its current liabilities are impacting 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. In brief, it is a useful tool, but it is not without drawbacks. 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 Leggett & Platt:
0.13 = US$515m ÷ (US$4.8b – US$928m) (Based on the trailing twelve months to December 2019.)
Therefore, Leggett & Platt has an ROCE of 13%.
Does Leggett & Platt Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. We can see Leggett & Platt’s ROCE is around the 12% average reported by the Consumer Durables industry. Independently of how Leggett & Platt compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Leggett & Platt’s current ROCE of 13% is lower than its ROCE in the past, which was 21%, 3 years ago. So investors might consider if it has had issues recently. You can see in the image below how Leggett & Platt’s ROCE compares to its industry. Click to see more on 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 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 Leggett & Platt’s ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Leggett & Platt has current liabilities of US$928m and total assets of US$4.8b. As a result, its current liabilities are equal to approximately 19% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
What We Can Learn From Leggett & Platt’s ROCE
With that in mind, Leggett & Platt’s ROCE appears pretty good. There might be better investments than Leggett & Platt 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.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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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