Today we’ll evaluate Hewlett Packard Enterprise Company (NYSE:HPE) to determine whether it could have potential as an investment idea. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First of all, we’ll work out how to calculate ROCE. Then we’ll compare its ROCE to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. In the end, ROCE 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 Hewlett Packard Enterprise:
0.029 = US$1.1b ÷ (US$55b – US$17b) (Based on the trailing twelve months to October 2018.)
Therefore, Hewlett Packard Enterprise has an ROCE of 2.9%.
Does Hewlett Packard Enterprise Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. In this analysis, Hewlett Packard Enterprise’s ROCE appears meaningfully below the 18% average reported by the Tech industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how Hewlett Packard Enterprise compares to its industry, its ROCE in absolute terms is low; not much better than the ~2.9% available in government bonds. There are potentially more appealing investments elsewhere.
As we can see, Hewlett Packard Enterprise currently has an ROCE of 2.9%, less than the 5.2% it reported 3 years ago. This makes us wonder if the business is facing new challenges.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. You can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect Hewlett Packard Enterprise’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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Hewlett Packard Enterprise has total assets of US$55b and current liabilities of US$17b. Therefore its current liabilities are equivalent to approximately 31% of its total assets. In light of sufficient current liabilities to noticeably boost the ROCE, Hewlett Packard Enterprise’s ROCE is concerning.
What We Can Learn From Hewlett Packard Enterprise’s ROCE
There are likely better investments out there. Of course you might be able to find a better stock than Hewlett Packard Enterprise. So you may wish to see this free collection of other companies that have grown earnings strongly.
Of course Hewlett Packard Enterprise may not be the best stock to buy. So you may wish to see this free collection of other companies that have high ROE and low debt.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.