Yahoo Finance Why We Like Renew Holdings plc’s (LON:RNWH) 26% Return On Capital Employed
Today we'll evaluate Renew Holdings plc (LON:RNWH) 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, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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?
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 Renew Holdings:
0.26 = UK£30m ÷ (UK£294m - UK£181m) (Based on the trailing twelve months to March 2019.)
Therefore, Renew Holdings has an ROCE of 26%.
See our latest analysis for Renew Holdings
Is Renew Holdings's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Renew Holdings's ROCE is meaningfully better than the 19% average in the Construction industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Setting aside the comparison to its industry for a moment, Renew Holdings's ROCE in absolute terms currently looks quite high.
Renew Holdings's current ROCE of 26% is lower than its ROCE in the past, which was 41%, 3 years ago. This makes us wonder if the business is facing new challenges. The image below shows how Renew Holdings'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 Renew Holdings.
Do Renew Holdings's Current Liabilities Skew 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Renew Holdings has total assets of UK£294m and current liabilities of UK£181m. As a result, its current liabilities are equal to approximately 62% of its total assets. While a high level of current liabilities boosts its ROCE, Renew Holdings's returns are still very good.
Our Take On Renew Holdings's ROCE
So to us, the company is potentially worth investigating further. Renew Holdings shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.
