Today we’ll evaluate Emerson Electric Co. (NYSE:EMR) to determine whether it could have potential as an investment idea. 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, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. Then we’ll determine how its current liabilities are affecting 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. 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?
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 Emerson Electric:
0.22 = US$3.0b ÷ (US$22b – US$7.9b) (Based on the trailing twelve months to March 2020.)
So, Emerson Electric has an ROCE of 22%.
Is Emerson Electric’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Emerson Electric’s ROCE is meaningfully higher than the 10% average in the Electrical industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Putting aside its position relative to its industry for now, in absolute terms, Emerson Electric’s ROCE is currently very good.
You can click on the image below to see (in greater detail) how Emerson Electric’s past growth compares to other companies.
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 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 Emerson Electric.
How Emerson Electric’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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Emerson Electric has current liabilities of US$7.9b and total assets of US$22b. As a result, its current liabilities are equal to approximately 37% of its total assets. Emerson Electric’s ROCE is boosted somewhat by its middling amount of current liabilities.
Our Take On Emerson Electric’s ROCE
Even so, it has a great ROCE, and could be an attractive prospect for further research. Emerson Electric 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 are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.