Today we'll evaluate Wm Morrison Supermarkets PLC (LON:MRW) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the 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. 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'.
So, How Do We Calculate ROCE?
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 Wm Morrison Supermarkets:
0.067 = UK£471m ÷ (UK£11b - UK£3.5b) (Based on the trailing twelve months to August 2019.)
Therefore, Wm Morrison Supermarkets has an ROCE of 6.7%.
Is Wm Morrison Supermarkets's ROCE Good?
One way to assess ROCE is to compare similar companies. It appears that Wm Morrison Supermarkets's ROCE is fairly close to the Consumer Retailing industry average of 6.7%. Setting aside the industry comparison for now, Wm Morrison Supermarkets's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.
You can see in the image below how Wm Morrison Supermarkets's ROCE compares to its industry. Click to see more on past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. 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 Wm Morrison Supermarkets.
How Wm Morrison Supermarkets's Current Liabilities Impact 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. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Wm Morrison Supermarkets has total assets of UK£11b and current liabilities of UK£3.5b. As a result, its current liabilities are equal to approximately 33% of its total assets. Wm Morrison Supermarkets's middling level of current liabilities have the effect of boosting its ROCE a bit.
Our Take On Wm Morrison Supermarkets's ROCE
With this level of liabilities and a mediocre ROCE, there are potentially better investments out there. 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).
I will like Wm Morrison Supermarkets better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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