Today we’ll look at McCormick & Company, Incorporated (NYSE:MKC) and reflect on its potential as an investment. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First up, we’ll look at what ROCE is and how we calculate it. Next, we’ll compare it to others in its industry. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
What is 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. Generally speaking a higher ROCE is better. 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.
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 McCormick:
0.12 = US$996m ÷ (US$10b – US$2.2b) (Based on the trailing twelve months to November 2019.)
So, McCormick has an ROCE of 12%.
Does McCormick Have A Good ROCE?
One way to assess ROCE is to compare similar companies. McCormick’s ROCE appears to be substantially greater than the 8.7% average in the Food 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. Independently of how McCormick compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
McCormick’s current ROCE of 12% is lower than 3 years ago, when the company reported a 20% ROCE. Therefore we wonder if the company is facing new headwinds. The image below shows how McCormick’s ROCE compares to its industry, and you can click it to see more detail on its past growth.
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. 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 McCormick’s 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
McCormick has current liabilities of US$2.2b and total assets of US$10b. Therefore its current liabilities are equivalent to approximately 21% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
What We Can Learn From McCormick’s ROCE
This is good to see, and with a sound ROCE, McCormick could be worth a closer look. There might be better investments than McCormick 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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