Yahoo Finance Why Dignity plc’s (LON:DTY) Return On Capital Employed Looks Uninspiring
Today we'll evaluate Dignity plc (LON:DTY) to determine whether it could have potential as an investment idea. 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. And finally, we'll look at how its current liabilities are impacting its ROCE.
Understanding 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. 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?
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 Dignity:
0.056 = UK£43m ÷ (UK£849m - UK£76m) (Based on the trailing twelve months to June 2019.)
So, Dignity has an ROCE of 5.6%.
See our latest analysis for Dignity
Is Dignity's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In this analysis, Dignity's ROCE appears meaningfully below the 12% average reported by the Consumer Services industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how Dignity stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.
We can see that , Dignity currently has an ROCE of 5.6%, less than the 15% it reported 3 years ago. This makes us wonder if the business is facing new challenges. You can see in the image below how Dignity's ROCE compares to its industry. Click to see more on 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. 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 Dignity.
Dignity'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. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Dignity has total assets of UK£849m and current liabilities of UK£76m. As a result, its current liabilities are equal to approximately 8.9% of its total assets. With low levels of current liabilities, at least Dignity's mediocre ROCE is not unduly boosted.
What We Can Learn From Dignity's ROCE
Dignity looks like an ok business, but on this analysis it is not at the top of our buy list. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
If you are like me, then you will not want to miss this free list of growing companies that insiders are 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 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.
