Yahoo Finance Why You Should Care About Ricardo plc’s (LON:RCDO) Low Return On Capital
Today we'll look at Ricardo plc (LON:RCDO) and reflect on its potential as an investment. 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 of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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 Ricardo:
0.15 = UK£37m ÷ (UK£346m - UK£106m) (Based on the trailing twelve months to December 2018.)
Therefore, Ricardo has an ROCE of 15%.
Check out our latest analysis for Ricardo
Is Ricardo's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. We can see Ricardo's ROCE is meaningfully below the Professional Services industry average of 19%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Separate from Ricardo'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 Ricardo's past growth compares to other companies.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
How Ricardo'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 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.
Ricardo has total liabilities of UK£106m and total assets of UK£346m. Therefore its current liabilities are equivalent to approximately 31% of its total assets. Ricardo has a middling amount of current liabilities, increasing its ROCE somewhat.
Our Take On Ricardo's ROCE
Ricardo's ROCE does look good, but the level of current liabilities also contribute to that. Ricardo 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.
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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 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.
