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Today we’ll evaluate Lancaster Colony Corporation (NASDAQ:LANC) 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. 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. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’
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 Lancaster Colony:
0.24 = US$174m ÷ (US$875m – US$110m) (Based on the trailing twelve months to December 2018.)
Therefore, Lancaster Colony has an ROCE of 24%.
Is Lancaster Colony’s ROCE Good?
One way to assess ROCE is to compare similar companies. In our analysis, Lancaster Colony’s ROCE is meaningfully higher than the 9.2% average in the Food industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Setting aside the comparison to its industry for a moment, Lancaster Colony’s ROCE in absolute terms currently looks quite high.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the 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 Lancaster Colony.
How Lancaster Colony’s Current Liabilities Impact 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Lancaster Colony has total assets of US$875m and current liabilities of US$110m. Therefore its current liabilities are equivalent to approximately 13% of its total assets. This is quite a low level of current liabilities which would not greatly boost the already high ROCE.
Our Take On Lancaster Colony’s ROCE
Low current liabilities and high ROCE is a good combination, making Lancaster Colony look quite interesting. Of course you might be able to find a better stock than Lancaster Colony. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like Lancaster Colony 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 email@example.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.