Today we’ll evaluate Waste Management, Inc. (NYSE:WM) to determine whether it could have potential as an investment idea. 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. Then we’ll compare its ROCE to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the 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 Waste Management:
0.14 = US$2.7b ÷ (US$23b – US$3.1b) (Based on the trailing twelve months to December 2018.)
So, Waste Management has an ROCE of 14%.
Is Waste Management’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Waste Management’s ROCE appears to be substantially greater than the 11% average in the Commercial Services industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Waste Management compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Waste Management.
How Waste Management’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 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.
Waste Management has total liabilities of US$3.1b and total assets of US$23b. As a result, its current liabilities are equal to approximately 14% of its total assets. Low current liabilities are not boosting the ROCE too much.
What We Can Learn From Waste Management’s ROCE
Overall, Waste Management has a decent ROCE and could be worthy of further research. You might be able to find a better buy than Waste Management. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
I will like Waste Management 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 firstname.lastname@example.org. 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.