Today we are going to look at W.W. Grainger, Inc. (NYSE:GWW) to see whether it might be an attractive investment prospect. 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.
First up, we’ll look at what ROCE is and how we calculate it. Second, we’ll look at its ROCE compared to similar companies. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. In brief, ROCE 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’.
So, How Do We Calculate ROCE?
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 W.W. Grainger:
0.30 = US$1.2b ÷ (US$5.9b – US$1.5b) (Based on the trailing twelve months to September 2018.)
Therefore, W.W. Grainger has an ROCE of 30%.
Is W.W. Grainger’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. W.W. Grainger’s ROCE appears to be substantially greater than the 7.9% average in the Trade Distributors industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Setting aside the comparison to its industry for a moment, W.W. Grainger’s ROCE in absolute terms currently looks quite high.
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 W.W. Grainger.
W.W. Grainger’s Current Liabilities And Their Impact On Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) unfairly boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
W.W. Grainger has total liabilities of US$1.5b and total assets of US$5.9b. As a result, its current liabilities are equal to approximately 25% of its total assets. The fairly low level of current liabilities won’t have much impact on the already great ROCE.
Our Take On W.W. Grainger’s ROCE
Low current liabilities and high ROCE is a good combination, making W.W. Grainger look quite interesting. We like to see a high ROCE, but it’s not the only data point we check. One thing to consider is if insiders have bought shares recently.
If you would prefer check out another company — one with potentially superior financials — then do not miss this free list of interesting companies, that have HIGH return on equity and low debt.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.