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Today we’ll evaluate Resolute Forest Products Inc. (NYSE:RFP) 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 of all, we’ll work out how to 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 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. 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?
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 Resolute Forest Products:
0.13 = US$434m ÷ (US$3.8b – US$441m) (Based on the trailing twelve months to March 2019.)
Therefore, Resolute Forest Products has an ROCE of 13%.
Does Resolute Forest Products Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. We can see Resolute Forest Products’s ROCE is around the 11% average reported by the Forestry industry. Separate from Resolute Forest Products’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Our data shows that Resolute Forest Products currently has an ROCE of 13%, compared to its ROCE of 1.1% 3 years ago. This makes us wonder if the company is improving.
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. 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 Resolute Forest Products’s Current Liabilities Skew 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 ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Resolute Forest Products has total liabilities of US$441m and total assets of US$3.8b. Therefore its current liabilities are equivalent to approximately 12% of its total assets. Low current liabilities are not boosting the ROCE too much.
What We Can Learn From Resolute Forest Products’s ROCE
This is good to see, and with a sound ROCE, Resolute Forest Products could be worth a closer look. Resolute Forest Products 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.
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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 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.