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What Can We Make Of The Berkeley Group Holdings plc’s (LON:BKG) High Return On Capital?

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Today we’ll look at The Berkeley Group Holdings plc (LON:BKG) and reflect on its potential as an investment. 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, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. Last but not least, we’ll look at what impact its current liabilities have on 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. 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’.

How Do You Calculate Return On Capital Employed?

Analysts use this formula to calculate return on capital employed:

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Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)

Or for Berkeley Group Holdings:

0.22 = UK£780m ÷ (UK£4.8b – UK£1.7b) (Based on the trailing twelve months to October 2018.)

Therefore, Berkeley Group Holdings has an ROCE of 22%.

See our latest analysis for Berkeley Group Holdings

Is Berkeley Group Holdings’s ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Berkeley Group Holdings’s ROCE is meaningfully higher than the 18% average in the Consumer Durables industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of the industry comparison, in absolute terms, Berkeley Group Holdings’s ROCE currently appears to be excellent.

LSE:BKG Last Perf February 11th 19
LSE:BKG Last Perf February 11th 19

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 only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Berkeley Group Holdings.

Berkeley Group Holdings’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 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Berkeley Group Holdings has total assets of UK£4.8b and current liabilities of UK£1.7b. Therefore its current liabilities are equivalent to approximately 35% of its total assets. Berkeley Group Holdings’s ROCE is boosted somewhat by its middling amount of current liabilities.

Our Take On Berkeley Group Holdings’s ROCE

Despite this, it reports a high ROCE, and may be worth investigating further. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.