Today we’ll evaluate Honeywell International Inc. (NYSE:HON) 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.
Firstly, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Then we’ll determine how its current liabilities are affecting 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, 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?
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 Honeywell International:
0.20 = US$7.8b ÷ (US$58b – US$19b) (Based on the trailing twelve months to December 2018.)
So, Honeywell International has an ROCE of 20%.
Is Honeywell International’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. It appears that Honeywell International’s ROCE is fairly close to the Industrials industry average of 19%. Separate from Honeywell International’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for Honeywell International.
Do Honeywell International’s Current Liabilities Skew 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 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Honeywell International has total assets of US$58b and current liabilities of US$19b. Therefore its current liabilities are equivalent to approximately 33% of its total assets. With this level of current liabilities, Honeywell International’s ROCE is boosted somewhat.
Our Take On Honeywell International’s ROCE
Honeywell International’s ROCE does look good, but the level of current liabilities also contribute to that. Of course you might be able to find a better stock than Honeywell International. So you may wish to see this free collection of other companies that have grown earnings strongly.
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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