Lamb Weston Holdings, Inc. (NYSE:LW) Earns A Nice Return On Capital Employed

Today we'll look at Lamb Weston Holdings, Inc. (NYSE:LW) and reflect on its potential as an investment. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

First up, we'll look at what ROCE is and how we calculate it. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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?

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 Lamb Weston Holdings:

0.26 = US$646m ÷ (US$3.1b - US$667m) (Based on the trailing twelve months to February 2019.)

So, Lamb Weston Holdings has an ROCE of 26%.

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Does Lamb Weston Holdings Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. Lamb Weston Holdings's ROCE appears to be substantially greater than the 8.1% average in the Food industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Putting aside its position relative to its industry for now, in absolute terms, Lamb Weston Holdings's ROCE is currently very good.

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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 Lamb Weston Holdings.

What Are Current Liabilities, And How Do They Affect Lamb Weston Holdings'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. 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Lamb Weston Holdings has total liabilities of US$667m and total assets of US$3.1b. As a result, its current liabilities are equal to approximately 21% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.

The Bottom Line On Lamb Weston Holdings's ROCE

Low current liabilities and high ROCE is a good combination, making Lamb Weston Holdings look quite interesting. There might be better investments than Lamb Weston Holdings out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.

I will like Lamb Weston Holdings better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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 editorial-team@simplywallst.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.