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Should You Like Auto Trader Group plc’s (LON:AUTO) High Return On Capital Employed?

Simply Wall St

Today we'll look at Auto Trader Group plc (LON:AUTO) 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 of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.

What is 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. 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.

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 Auto Trader Group:

0.58 = UK£252m ÷ (UK£475m - UK£44m) (Based on the trailing twelve months to September 2019.)

So, Auto Trader Group has an ROCE of 58%.

View our latest analysis for Auto Trader Group

Is Auto Trader Group's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Auto Trader Group's ROCE is meaningfully higher than the 15% average in the Interactive Media and Services industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Setting aside the comparison to its industry for a moment, Auto Trader Group's ROCE in absolute terms currently looks quite high.

You can see in the image below how Auto Trader Group's ROCE compares to its industry. Click to see more on past growth.

LSE:AUTO Past Revenue and Net Income, December 7th 2019

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, 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.

Auto Trader Group's Current Liabilities And Their Impact On Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Auto Trader Group has total assets of UK£475m and current liabilities of UK£44m. Therefore its current liabilities are equivalent to approximately 9.3% of its total assets. Auto Trader Group has low current liabilities, which have a negligible impact on its relatively good ROCE.

What We Can Learn From Auto Trader Group's ROCE

This is an attractive combination and suggests the company could have potential. Auto Trader Group 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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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.

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. Thank you for reading.