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Today we'll look at QinetiQ Group plc (LON:QQ.) and reflect on its potential as an investment. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on 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. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. 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?
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 QinetiQ Group:
0.12 = UK£113m ÷ (UK£1.2b - UK£302m) (Based on the trailing twelve months to September 2018.)
Therefore, QinetiQ Group has an ROCE of 12%.
Does QinetiQ Group Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. We can see QinetiQ Group's ROCE is around the 11% average reported by the Aerospace & Defense industry. Separate from QinetiQ Group's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
As we can see, QinetiQ Group currently has an ROCE of 12%, less than the 33% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for QinetiQ Group.
QinetiQ Group's Current Liabilities And Their Impact On Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
QinetiQ Group has total assets of UK£1.2b and current liabilities of UK£302m. Therefore its current liabilities are equivalent to approximately 25% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
The Bottom Line On QinetiQ Group's ROCE
Overall, QinetiQ Group has a decent ROCE and could be worthy of further research. Of course you might be able to find a better stock than QinetiQ Group. So you may wish to see this free collection of other companies that have grown earnings strongly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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 email@example.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.