Today we are going to look at Parker-Hannifin Corporation (NYSE:PH) 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, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
Understanding 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. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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?
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 Parker-Hannifin:
0.17 = US$2.1b ÷ (US$15b – US$3.5b) (Based on the trailing twelve months to December 2018.)
Therefore, Parker-Hannifin has an ROCE of 17%.
Does Parker-Hannifin Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that Parker-Hannifin’s ROCE is meaningfully better than the 11% average in the Machinery industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from Parker-Hannifin’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Parker-Hannifin.
Do Parker-Hannifin’s Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Parker-Hannifin has total liabilities of US$3.5b and total assets of US$15b. Therefore its current liabilities are equivalent to approximately 23% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
The Bottom Line On Parker-Hannifin’s ROCE
This is good to see, and with a sound ROCE, Parker-Hannifin could be worth a closer look. Parker-Hannifin 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 Parker-Hannifin 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.