Today we’ll look at Toll Brothers, Inc. (NYSE:TOL) and reflect on its potential as an investment. 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. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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 Toll Brothers:
0.099 = US$886m ÷ (US$10b – US$1.3b) (Based on the trailing twelve months to April 2019.)
Therefore, Toll Brothers has an ROCE of 9.9%.
Is Toll Brothers’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. It appears that Toll Brothers’s ROCE is fairly close to the Consumer Durables industry average of 12%. Separate from how Toll Brothers stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.
Our data shows that Toll Brothers currently has an ROCE of 9.9%, compared to its ROCE of 6.6% 3 years ago. This makes us wonder if the company is improving.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Toll Brothers’s Current Liabilities And Their Impact On Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Toll Brothers has total liabilities of US$1.3b and total assets of US$10b. Therefore its current liabilities are equivalent to approximately 13% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
Our Take On Toll Brothers’s ROCE
That said, Toll Brothers’s ROCE is mediocre, there may be more attractive investments around. Of course, you might also be able to find a better stock than Toll Brothers. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like Toll Brothers 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 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.