Today we’ll evaluate HNI Corporation (NYSE:HNI) to determine whether it could have potential as an investment idea. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First up, we’ll look at what ROCE is and how we calculate it. Then we’ll compare its ROCE to similar companies. 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 measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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?
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 HNI:
0.15 = US$147m ÷ (US$1.5b – US$459m) (Based on the trailing twelve months to September 2019.)
Therefore, HNI has an ROCE of 15%.
Is HNI’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, HNI’s ROCE is meaningfully higher than the 9.4% average in the Commercial Services 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. Regardless of where HNI sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
HNI’s current ROCE of 15% is lower than 3 years ago, when the company reported a 21% ROCE. So investors might consider if it has had issues recently. The image below shows how HNI’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 HNI.
How HNI’s Current Liabilities Impact 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. 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.
HNI has total liabilities of US$459m and total assets of US$1.5b. As a result, its current liabilities are equal to approximately 31% of its total assets. HNI has a medium level of current liabilities, which would boost the ROCE.
Our Take On HNI’s ROCE
HNI’s ROCE does look good, but the level of current liabilities also contribute to that. HNI shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
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 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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