Today we are going to look at Parker-Hannifin Corporation (NYSE:PH) to see whether it might be an attractive investment prospect. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
Firstly, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. In the end, ROCE 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.’
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 Parker-Hannifin:
0.17 = US$2.0b ÷ (US$15b – US$3.3b) (Based on the trailing twelve months to September 2018.)
So, Parker-Hannifin has an ROCE of 17%.
Is Parker-Hannifin’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Parker-Hannifin’s ROCE is meaningfully better than the 12% average in the Machinery industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Parker-Hannifin compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
It is important to remember that ROCE shows past performance, and is 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, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for Parker-Hannifin.
What Are Current Liabilities, And How Do They Affect Parker-Hannifin’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 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Parker-Hannifin has total liabilities of US$3.3b and total assets of US$15b. As a result, its current liabilities are equal to approximately 21% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
Our Take On Parker-Hannifin’s ROCE
This is good to see, and with a sound ROCE, Parker-Hannifin could be worth a closer look. A good or bad ROCE tells us something about a business, but we need to do more research before making a purchase. One data point to check is if insiders have bought shares recently.
Of course Parker-Hannifin may not be the best stock to buy. So you may wish to see this free collection of other companies that have high ROE 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 firstname.lastname@example.org.