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Why United Carpets Group plc’s (LON:UCG) Return On Capital Employed Might Be A Concern

Simply Wall St

Today we'll look at United Carpets Group plc (LON:UCG) 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, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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 United Carpets Group:

0.098 = UK£588k ÷ (UK£11m - UK£5.2m) (Based on the trailing twelve months to March 2019.)

Therefore, United Carpets Group has an ROCE of 9.8%.

View our latest analysis for United Carpets Group

Does United Carpets Group Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. In this analysis, United Carpets Group's ROCE appears meaningfully below the 13% average reported by the Specialty Retail industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how United Carpets Group compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

We can see that , United Carpets Group currently has an ROCE of 9.8%, less than the 31% it reported 3 years ago. So investors might consider if it has had issues recently. You can see in the image below how United Carpets Group's ROCE compares to its industry. Click to see more on past growth.

AIM:UCG Past Revenue and Net Income, August 29th 2019

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for United Carpets Group.

Do United Carpets Group's Current Liabilities Skew 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 counter this, investors can check if a company has high current liabilities relative to total assets.

United Carpets Group has total liabilities of UK£5.2m and total assets of UK£11m. Therefore its current liabilities are equivalent to approximately 46% of its total assets. With this level of current liabilities, United Carpets Group's ROCE is boosted somewhat.

The Bottom Line On United Carpets Group's ROCE

With a decent ROCE, the company could be interesting, but remember that the level of current liabilities make the ROCE look better. United Carpets Group 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.