Today we’ll look at Air Products and Chemicals, Inc. (NYSE:APD) and reflect on its potential as an investment. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
What is 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. In general, businesses with a higher ROCE are usually better quality. 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 Air Products and Chemicals:
0.12 = US$2.0b ÷ (US$19b – US$2.1b) (Based on the trailing twelve months to March 2019.)
Therefore, Air Products and Chemicals has an ROCE of 12%.
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Is Air Products and Chemicals’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. We can see Air Products and Chemicals’s ROCE is around the 11% average reported by the Chemicals industry. Independently of how Air Products and Chemicals 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. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. 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 Air Products and Chemicals.
What Are Current Liabilities, And How Do They Affect Air Products and Chemicals’s ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Air Products and Chemicals has total liabilities of US$2.1b and total assets of US$19b. Therefore its current liabilities are equivalent to approximately 11% of its total assets. Low current liabilities are not boosting the ROCE too much.
The Bottom Line On Air Products and Chemicals’s ROCE
With that in mind, Air Products and Chemicals’s ROCE appears pretty good. There might be better investments than Air Products and Chemicals out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
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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.