Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!
Today we’ll look at Canfor Corporation (TSE:CFP) 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 up, we’ll look at what ROCE is and how we calculate it. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect 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?
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 Canfor:
0.086 = CA$327m ÷ (CA$4.9b – CA$1.1b) (Based on the trailing twelve months to March 2019.)
So, Canfor has an ROCE of 8.6%.
Is Canfor’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. We can see Canfor’s ROCE is around the 10% average reported by the Forestry industry. Setting aside the industry comparison for now, Canfor’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.
In our analysis, Canfor’s ROCE appears to be 8.6%, compared to 3 years ago, when its ROCE was 5.1%. This makes us think about whether the company has been reinvesting shrewdly.
When considering this metric, keep in mind that it is backwards looking, and 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Canfor.
What Are Current Liabilities, And How Do They Affect Canfor’s 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Canfor has total liabilities of CA$1.1b and total assets of CA$4.9b. As a result, its current liabilities are equal to approximately 23% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
What We Can Learn From Canfor’s ROCE
If Canfor continues to earn an uninspiring ROCE, there may be better places to invest. You might be able to find a better investment than Canfor. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
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.