Today we’ll look at Harris Corporation (NYSE:HRS) and reflect on its potential as an investment. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
Firstly, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Then we’ll determine how its current liabilities are affecting 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. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’
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 Harris:
0.16 = US$1.3b ÷ (US$9.9b – US$1.8b) (Based on the trailing twelve months to December 2018.)
Therefore, Harris has an ROCE of 16%.
Does Harris Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Harris’s ROCE appears to be substantially greater than the 12% average in the Aerospace & Defense industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Harris compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Our data shows that Harris currently has an ROCE of 16%, compared to its ROCE of 11% 3 years ago. This makes us wonder if the company is improving.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect Harris’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.
Harris has total assets of US$9.9b and current liabilities of US$1.8b. Therefore its current liabilities are equivalent to approximately 18% of its total assets. Low current liabilities are not boosting the ROCE too much.
What We Can Learn From Harris’s ROCE
This is good to see, and with a sound ROCE, Harris could be worth a closer look. Harris looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
I will like Harris 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.