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Here's What Auto Trader Group plc's (LON:AUTO) ROCE Can Tell Us

Simply Wall St

Today we'll evaluate Auto Trader Group plc (LON:AUTO) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting 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. In general, businesses with a higher ROCE are usually better quality. 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.'

How Do You Calculate Return On Capital Employed?

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:

0.65 = UK£231m ÷ (UK£413m - UK£57m) (Based on the trailing twelve months to September 2018.)

So, Auto Trader Group has an ROCE of 65%.

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Does Auto Trader Group Have A Good ROCE?

One way to assess ROCE is to compare similar companies. In our analysis, Auto Trader Group's ROCE is meaningfully higher than the 17% average in the Interactive Media and Services 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, Auto Trader Group's ROCE is currently very good.

Our data shows that Auto Trader Group currently has an ROCE of 65%, compared to its ROCE of 43% 3 years ago. This makes us wonder if the company is improving.

LSE:AUTO Past Revenue and Net Income, May 20th 2019

It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Auto Trader Group.

Do Auto Trader Group's Current Liabilities Skew 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Auto Trader Group has total liabilities of UK£57m and total assets of UK£413m. Therefore its current liabilities are equivalent to approximately 14% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.

What We Can Learn From Auto Trader Group's ROCE

This is good to see, and with such a high ROCE, Auto Trader Group may be worth a closer look. There might be better investments than Auto Trader Group 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 like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.