Today we’ll evaluate Eagle Materials Inc. (NYSE:EXP) to determine whether it could have potential as an investment idea. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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’.
So, How Do We Calculate ROCE?
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 Eagle Materials:
0.13 = US$292m ÷ (US$2.4b – US$181m) (Based on the trailing twelve months to December 2018.)
Therefore, Eagle Materials has an ROCE of 13%.
Does Eagle Materials Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Using our data, we find that Eagle Materials’s ROCE is meaningfully better than the 8.5% average in the Basic Materials industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Eagle Materials compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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.
Do Eagle Materials’s Current Liabilities Skew 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. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Eagle Materials has total liabilities of US$181m and total assets of US$2.4b. As a result, its current liabilities are equal to approximately 7.7% of its total assets. In addition to low current liabilities (making a negligible impact on ROCE), Eagle Materials earns a sound return on capital employed.
The Bottom Line On Eagle Materials’s ROCE
If it is able to keep this up, Eagle Materials could be attractive. But note: Eagle Materials may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.