Why We’re Not Keen On Tennant Company’s (NYSE:TNC) 8.8% Return On Capital

Today we are going to look at Tennant Company (NYSE:TNC) to see whether it might be an attractive investment prospect. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

First of all, we’ll work out how to calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. 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 measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that ‘one dollar invested in the company generates value of more than one dollar’.

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 Tennant:

0.088 = US$65m ÷ (US$993m – US$249m) (Based on the trailing twelve months to December 2018.)

So, Tennant has an ROCE of 8.8%.

See our latest analysis for Tennant

Is Tennant’s ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. We can see Tennant’s ROCE is meaningfully below the Machinery industry average of 12%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Setting aside the industry comparison for now, Tennant’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.

Tennant’s current ROCE of 8.8% is lower than 3 years ago, when the company reported a 23% ROCE. So investors might consider if it has had issues recently.

NYSE:TNC Past Revenue and Net Income, March 20th 2019
NYSE:TNC Past Revenue and Net Income, March 20th 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, 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 Tennant.

How Tennant’s Current Liabilities Impact Its 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Tennant has total assets of US$993m and current liabilities of US$249m. Therefore its current liabilities are equivalent to approximately 25% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.

What We Can Learn From Tennant’s ROCE

That said, Tennant’s ROCE is mediocre, there may be more attractive investments around. Of course you might be able to find a better stock than Tennant. So you may wish to see this free collection of other companies that have grown earnings strongly.

I will like Tennant 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.