Yahoo Finance Is Chemring Group PLC's (LON:CHG) Capital Allocation Ability Worth Your Time?
Today we are going to look at Chemring Group PLC (LON:CHG) to see whether it might be an attractive investment prospect. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
Firstly, 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.
Return On Capital Employed (ROCE): What is it?
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. In brief, it is a useful tool, but it is not without drawbacks. 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 Chemring Group:
0.093 = UK£32m ÷ (UK£498m - UK£149m) (Based on the trailing twelve months to October 2019.)
So, Chemring Group has an ROCE of 9.3%.
View our latest analysis for Chemring Group
Does Chemring Group Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Using our data, Chemring Group's ROCE appears to be around the 9.3% average of the Aerospace & Defense industry. Independently of how Chemring Group compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
We can see that, Chemring Group currently has an ROCE of 9.3% compared to its ROCE 3 years ago, which was 5.8%. This makes us think about whether the company has been reinvesting shrewdly. You can see in the image below how Chemring Group's ROCE compares to its industry. Click to see more on past growth.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for Chemring Group.
Chemring Group's Current Liabilities And Their Impact On Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Chemring Group has current liabilities of UK£149m and total assets of UK£498m. Therefore its current liabilities are equivalent to approximately 30% of its total assets. Low current liabilities are not boosting the ROCE too much.
Our Take On Chemring Group's ROCE
With that in mind, Chemring Group's ROCE appears pretty good. Chemring Group shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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.
