Today we'll evaluate Renishaw plc (LON:RSW) to determine whether it could have potential as an investment idea. 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.
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. Generally speaking a higher ROCE is better. 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 Renishaw:
0.093 = UK£62m ÷ (UK£736m - UK£68m) (Based on the trailing twelve months to December 2019.)
So, Renishaw has an ROCE of 9.3%.
Is Renishaw's ROCE Good?
One way to assess ROCE is to compare similar companies. We can see Renishaw's ROCE is around the 9.3% average reported by the Electronic industry. Regardless of where Renishaw sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
We can see that, Renishaw currently has an ROCE of 9.3%, less than the 18% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds. The image below shows how Renishaw's ROCE compares to its industry, and you can click it to see more detail on its 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 misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Renishaw.
What Are Current Liabilities, And How Do They Affect Renishaw's ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Renishaw has current liabilities of UK£68m and total assets of UK£736m. Therefore its current liabilities are equivalent to approximately 9.3% of its total assets. Low current liabilities have only a minimal impact on Renishaw's ROCE, making its decent returns more credible.
Our Take On Renishaw's ROCE
If it is able to keep this up, Renishaw could be attractive. Renishaw 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.
Renishaw is not the only stock insiders are buying. So take a peek at this free list of growing companies with insider buying.
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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.