Today we’ll look at ITT Inc. (NYSE:ITT) and reflect on its potential as an investment. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First of all, we’ll work out how to calculate ROCE. Next, we’ll compare it to others in its industry. Then we’ll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.
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 ITT:
0.12 = US$387m ÷ (US$4.1b – US$889m) (Based on the trailing twelve months to September 2019.)
Therefore, ITT has an ROCE of 12%.
Does ITT Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. It appears that ITT’s ROCE is fairly close to the Machinery industry average of 11%. Independently of how ITT compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Take a look at the image below to see how ITT’s past growth compares to the average in its industry.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. 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 ITT’s ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.
ITT has total liabilities of US$889m and total assets of US$4.1b. As a result, its current liabilities are equal to approximately 22% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
What We Can Learn From ITT’s ROCE
With that in mind, ITT’s ROCE appears pretty good. ITT 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.
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