The Coca-Cola Company (NYSE:KO) Is Employing Capital Very Effectively

Today we are going to look at The Coca-Cola Company (NYSE:KO) to see whether it might be an attractive investment prospect. 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 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?

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 Coca-Cola:

0.18 = US\$9.5b ÷ (US\$83b – US\$29b) (Based on the trailing twelve months to December 2018.)

Therefore, Coca-Cola has an ROCE of 18%.

Does Coca-Cola Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Coca-Cola’s ROCE is meaningfully higher than the 11% average in the Beverage industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where Coca-Cola sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

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. 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.

How Coca-Cola’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 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Coca-Cola has total assets of US\$83b and current liabilities of US\$29b. As a result, its current liabilities are equal to approximately 35% of its total assets. Coca-Cola has a medium level of current liabilities, which would boost the ROCE.

What We Can Learn From Coca-Cola’s ROCE

While its ROCE looks good, it’s worth remembering that the current liabilities are making the business look better. Of course you might be able to find a better stock than Coca-Cola. So you may wish to see this free collection of other companies that have grown earnings strongly.

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.