Yahoo Finance Should You Like Inchcape plc’s (LON:INCH) High Return On Capital Employed?
Today we are going to look at Inchcape plc (LON:INCH) to see whether it might be an attractive investment prospect. 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. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for Inchcape:
0.15 = UK£368m ÷ (UK£5.0b - UK£2.7b) (Based on the trailing twelve months to June 2019.)
So, Inchcape has an ROCE of 15%.
View our latest analysis for Inchcape
Does Inchcape Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Inchcape's ROCE appears to be substantially greater than the 12% average in the Retail Distributors 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. Separate from Inchcape's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
You can click on the image below to see (in greater detail) how Inchcape's past growth compares to other companies.
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, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for Inchcape.
Inchcape'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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Inchcape has total assets of UK£5.0b and current liabilities of UK£2.7b. As a result, its current liabilities are equal to approximately 53% of its total assets. Inchcape has a relatively high level of current liabilities, boosting its ROCE meaningfully.
What We Can Learn From Inchcape's ROCE
While its ROCE looks decent, it wouldn't look so good if it reduced current liabilities. Inchcape 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.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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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. Thank you for reading.
