Yahoo Finance Here’s why ABM Industries Incorporated’s (NYSE:ABM) Returns On Capital Matters So Much
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Today we’ll evaluate ABM Industries Incorporated (NYSE:ABM) 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. 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.
What is 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. In general, businesses with a higher ROCE are usually better quality. 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?
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 ABM Industries:
0.067 = US$191m ÷ (US$3.6b – US$793m) (Based on the trailing twelve months to October 2018.)
Therefore, ABM Industries has an ROCE of 6.7%.
Check out our latest analysis for ABM Industries
Is ABM Industries’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, ABM Industries’s ROCE appears meaningfully below the 11% average reported by the Commercial Services industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Setting aside the industry comparison for now, ABM Industries’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.
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. ROCE is, after all, simply a snap shot of a single year. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect ABM Industries’s ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
ABM Industries has total assets of US$3.6b and current liabilities of US$793m. As a result, its current liabilities are equal to approximately 22% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
What We Can Learn From ABM Industries’s ROCE
That said, ABM Industries’s ROCE is mediocre, there may be more attractive investments around. Of course you might be able to find a better stock than ABM Industries. So you may wish to see this free collection of other companies that have grown earnings strongly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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 editorial-team@simplywallst.com.
