What Can We Make Of Simpson Manufacturing Co., Inc.’s (NYSE:SSD) High Return On Capital?

Today we’ll evaluate Simpson Manufacturing Co., Inc. (NYSE:SSD) to determine whether it could have potential as an investment idea. 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.

First of all, we’ll work out how to calculate ROCE. Then we’ll compare its ROCE to similar companies. Last but not least, we’ll look at what impact its current liabilities have on 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. 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?

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 Simpson Manufacturing:

0.19 = US$167m ÷ (US$1.0b – US$151m) (Based on the trailing twelve months to March 2019.)

Therefore, Simpson Manufacturing has an ROCE of 19%.

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Is Simpson Manufacturing’s ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Simpson Manufacturing’s ROCE is meaningfully better than the 13% average in the Building industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where Simpson Manufacturing sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

Our data shows that Simpson Manufacturing currently has an ROCE of 19%, compared to its ROCE of 14% 3 years ago. This makes us think the business might be improving.

NYSE:SSD Past Revenue and Net Income, May 24th 2019
NYSE:SSD Past Revenue and Net Income, May 24th 2019

It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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 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 Simpson Manufacturing.

How Simpson Manufacturing’s Current Liabilities Impact Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Simpson Manufacturing has total assets of US$1.0b and current liabilities of US$151m. Therefore its current liabilities are equivalent to approximately 15% of its total assets. Low current liabilities are not boosting the ROCE too much.

What We Can Learn From Simpson Manufacturing’s ROCE

This is good to see, and with a sound ROCE, Simpson Manufacturing could be worth a closer look. There might be better investments than Simpson Manufacturing out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.

I will like Simpson Manufacturing better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.