Today we are going to look at Balfour Beatty plc (LON:BBY) to see whether it might be an attractive investment prospect. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. 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. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. 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?
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 Balfour Beatty:
0.041 = UK£103m ÷ (UK£4.8b - UK£2.3b) (Based on the trailing twelve months to June 2019.)
Therefore, Balfour Beatty has an ROCE of 4.1%.
Is Balfour Beatty's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, Balfour Beatty's ROCE appears to be significantly below the 18% average in the Construction industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Regardless of how Balfour Beatty stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). There are potentially more appealing investments elsewhere.
Balfour Beatty reported an ROCE of 4.1% -- better than 3 years ago, when the company didn't make a profit. That suggests the business has returned to profitability. The image below shows how Balfour Beatty's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering this metric, keep in mind that it is backwards looking, and 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 only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Balfour Beatty.
Balfour Beatty's Current Liabilities And Their Impact On Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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.
Balfour Beatty has total liabilities of UK£2.3b and total assets of UK£4.8b. As a result, its current liabilities are equal to approximately 47% of its total assets. In light of sufficient current liabilities to noticeably boost the ROCE, Balfour Beatty's ROCE is concerning.
What We Can Learn From Balfour Beatty's ROCE
So researching other companies may be a better use of your time. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
I will like Balfour Beatty better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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 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.