Today we are going to look at French Connection Group PLC (LON:FCCN) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. 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:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for French Connection Group:
0.15 = UK£9.1m ÷ (UK£96m - UK£37m) (Based on the trailing twelve months to July 2019.)
So, French Connection Group has an ROCE of 15%.
Does French Connection Group Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. It appears that French Connection Group's ROCE is fairly close to the Specialty Retail industry average of 13%. Regardless of where French Connection Group sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
French Connection Group reported an ROCE of 15% -- better than 3 years ago, when the company didn't make a profit. That suggests the business has returned to profitability. You can see in the image below how French Connection Group's ROCE compares to its industry. Click to see more on past growth.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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, after all, simply a snap shot of a single year. How cyclical is French Connection Group? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
How French Connection Group's Current Liabilities Impact 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.
French Connection Group has total assets of UK£96m and current liabilities of UK£37m. Therefore its current liabilities are equivalent to approximately 39% of its total assets. With this level of current liabilities, French Connection Group's ROCE is boosted somewhat.
What We Can Learn From French Connection Group's ROCE
With a decent ROCE, the company could be interesting, but remember that the level of current liabilities make the ROCE look better. There might be better investments than French Connection 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).
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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. Thank you for reading.