Today we’ll look at MSC Industrial Direct Co., Inc. (NYSE:MSM) 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. Finally, we’ll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the 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. 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’.
So, How Do We Calculate ROCE?
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 MSC Industrial Direct:
0.22 = US$421m ÷ (US$2.3b – US$404m) (Based on the trailing twelve months to November 2019.)
Therefore, MSC Industrial Direct has an ROCE of 22%.
Does MSC Industrial Direct Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that MSC Industrial Direct’s ROCE is meaningfully better than the 9.4% average in the Trade Distributors industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Setting aside the comparison to its industry for a moment, MSC Industrial Direct’s ROCE in absolute terms currently looks quite high.
The image below shows how MSC Industrial Direct’s ROCE compares to its industry, and you can click it to see more detail on its past growth.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for MSC Industrial Direct.
Do MSC Industrial Direct’s Current Liabilities Skew Its ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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.
MSC Industrial Direct has current liabilities of US$404m and total assets of US$2.3b. Therefore its current liabilities are equivalent to approximately 17% 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 MSC Industrial Direct’s ROCE
Low current liabilities and high ROCE is a good combination, making MSC Industrial Direct look quite interesting. MSC Industrial Direct looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
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If you spot an error that warrants correction, please contact the editor at email@example.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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