Today we’ll look at International Paper Company (NYSE:IP) 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.
First up, we’ll look at what ROCE is and how we calculate it. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect 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. Generally speaking a higher ROCE is better. 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 International Paper:
0.095 = US$2.3b ÷ (US$33b – US$9.3b) (Based on the trailing twelve months to March 2020.)
So, International Paper has an ROCE of 9.5%.
Is International Paper’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, International Paper’s ROCE appears to be around the 9.5% average of the Packaging industry. Aside from the industry comparison, International Paper’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
In our analysis, International Paper’s ROCE appears to be 9.5%, compared to 3 years ago, when its ROCE was 4.7%. This makes us think about whether the company has been reinvesting shrewdly. You can see in the image below how International Paper’s ROCE compares to its industry. Click to see more on past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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 only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for International Paper.
What Are Current Liabilities, And How Do They Affect International Paper’s ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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.
International Paper has current liabilities of US$9.3b and total assets of US$33b. As a result, its current liabilities are equal to approximately 28% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
Our Take On International Paper’s ROCE
With that in mind, we’re not overly impressed with International Paper’s ROCE, so it may not be the most appealing prospect. You might be able to find a better investment than International Paper. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.
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