Today we’ll look at Fletcher Building Limited (NZSE:FBU) and reflect on its potential as an investment. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
Firstly, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
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. 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 Fletcher Building:
0.12 = NZ$708m ÷ (NZ$8.0b – NZ$2.4b) (Based on the trailing twelve months to December 2018.)
So, Fletcher Building has an ROCE of 12%.
Does Fletcher Building Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Fletcher Building’s ROCE appears to be around the 12% average of the Basic Materials industry. Independently of how Fletcher Building compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
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 misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for Fletcher Building.
What Are Current Liabilities, And How Do They Affect Fletcher Building’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. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Fletcher Building has total liabilities of NZ$2.4b and total assets of NZ$8.0b. As a result, its current liabilities are equal to approximately 29% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
Our Take On Fletcher Building’s ROCE
Overall, Fletcher Building has a decent ROCE and could be worthy of further research. There might be better investments than Fletcher Building 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.
I will like Fletcher Building better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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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.