Today we'll evaluate Faurecia S.E. (EPA:EO) to determine whether it could have potential as an investment idea. 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. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
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. 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 Faurecia:
0.15 = €1.2b ÷ (€16b - €8.3b) (Based on the trailing twelve months to December 2019.)
So, Faurecia has an ROCE of 15%.
Does Faurecia Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Faurecia's ROCE is meaningfully higher than the 12% average in the Auto Components industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Faurecia compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
You can click on the image below to see (in greater detail) how Faurecia's past growth compares to other companies.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. 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 Faurecia.
How Faurecia's Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Faurecia has current liabilities of €8.3b and total assets of €16b. As a result, its current liabilities are equal to approximately 51% of its total assets. Faurecia has a relatively high level of current liabilities, boosting its ROCE meaningfully.
Our Take On Faurecia's ROCE
The ROCE would not look as appealing if the company had fewer current liabilities. There might be better investments than Faurecia 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.
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 firstname.lastname@example.org. 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.
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