Today we’ll look at Avery Dennison Corporation (NYSE:AVY) 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. Second, we’ll look at its ROCE compared to similar companies. And finally, we’ll look at how its current liabilities are impacting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. 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.’
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 Avery Dennison:
0.25 = US$804m ÷ (US$5.2b – US$2.0b) (Based on the trailing twelve months to December 2018.)
So, Avery Dennison has an ROCE of 25%.
Does Avery Dennison Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that Avery Dennison’s ROCE is meaningfully better than the 12% average in the Packaging industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of the industry comparison, in absolute terms, Avery Dennison’s ROCE currently appears to be excellent.
Our data shows that Avery Dennison currently has an ROCE of 25%, compared to its ROCE of 20% 3 years ago. This makes us think the business might be improving.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Avery Dennison.
How Avery Dennison’s Current Liabilities Impact Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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.
Avery Dennison has total assets of US$5.2b and current liabilities of US$2.0b. As a result, its current liabilities are equal to approximately 39% of its total assets. A medium level of current liabilities boosts Avery Dennison’s ROCE somewhat.
What We Can Learn From Avery Dennison’s ROCE
Still, it has a high ROCE, and may be an interesting prospect for further research. Avery Dennison 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.
I will like Avery Dennison better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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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.