Today we’ll look at The Sherwin-Williams Company (NYSE:SHW) and reflect on its potential as an investment. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First of all, we’ll work out how to calculate ROCE. Next, we’ll compare it to others in its industry. And finally, we’ll look at how its current liabilities are impacting its ROCE.
Return On Capital Employed (ROCE): What is it?
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. 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?
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 Sherwin-Williams:
0.14 = US$2.0b ÷ (US$21b – US$6.3b) (Based on the trailing twelve months to June 2019.)
So, Sherwin-Williams has an ROCE of 14%.
Does Sherwin-Williams Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Sherwin-Williams’s ROCE is meaningfully better than the 10% average in the Chemicals industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of where Sherwin-Williams sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Sherwin-Williams’s current ROCE of 14% is lower than 3 years ago, when the company reported a 43% ROCE. This makes us wonder if the business is facing new challenges.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Sherwin-Williams.
How Sherwin-Williams’s Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Sherwin-Williams has total assets of US$21b and current liabilities of US$6.3b. As a result, its current liabilities are equal to approximately 30% of its total assets. Low current liabilities are not boosting the ROCE too much.
What We Can Learn From Sherwin-Williams’s ROCE
Overall, Sherwin-Williams has a decent ROCE and could be worthy of further research. Sherwin-Williams 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. Thank you for reading.