Today we’ll look at Renishaw plc (LON:RSW) 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. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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 Renishaw:
0.22 = UK£143m ÷ (UK£735m – UK£98m) (Based on the trailing twelve months to December 2018.)
Therefore, Renishaw has an ROCE of 22%.
Is Renishaw’s ROCE Good?
One way to assess ROCE is to compare similar companies. In our analysis, Renishaw’s ROCE is meaningfully higher than the 12% average in the Electronic industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of the industry comparison, in absolute terms, Renishaw’s ROCE currently appears to be excellent.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
How Renishaw’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. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Renishaw has total liabilities of UK£98m and total assets of UK£735m. Therefore its current liabilities are equivalent to approximately 13% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.
The Bottom Line On Renishaw’s ROCE
Low current liabilities and high ROCE is a good combination, making Renishaw look quite interesting. There might be better investments than Renishaw out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
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