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Today we are going to look at Hilton Grand Vacations Inc. (NYSE:HGV) to see whether it might be an attractive investment prospect. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First up, we’ll look at what ROCE is and how we calculate it. 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.
Understanding Return On Capital Employed (ROCE)
ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the 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?
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 Hilton Grand Vacations:
0.18 = US$483m ÷ (US$3.0b – US$229m) (Based on the trailing twelve months to March 2019.)
So, Hilton Grand Vacations has an ROCE of 18%.
Is Hilton Grand Vacations’s ROCE Good?
One way to assess ROCE is to compare similar companies. In our analysis, Hilton Grand Vacations’s ROCE is meaningfully higher than the 9.4% average in the Hospitality industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how Hilton Grand Vacations compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
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.
What Are Current Liabilities, And How Do They Affect Hilton Grand Vacations’s 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Hilton Grand Vacations has total assets of US$3.0b and current liabilities of US$229m. Therefore its current liabilities are equivalent to approximately 7.7% of its total assets. Low current liabilities have only a minimal impact on Hilton Grand Vacations’s ROCE, making its decent returns more credible.
Our Take On Hilton Grand Vacations’s ROCE
If it is able to keep this up, Hilton Grand Vacations could be attractive. Hilton Grand Vacations looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
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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.