Today we are going to look at Travis Perkins plc (LON:TPK) to see whether it might be an attractive investment prospect. 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. Then we’ll compare its ROCE to similar companies. Then we’ll determine how its current liabilities are affecting 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. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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 Travis Perkins:
0.047 = UK£212m ÷ (UK£6.4b – UK£1.9b) (Based on the trailing twelve months to December 2019.)
So, Travis Perkins has an ROCE of 4.7%.
Is Travis Perkins’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In this analysis, Travis Perkins’s ROCE appears meaningfully below the 13% average reported by the Trade Distributors industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how Travis Perkins 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.
Our data shows that Travis Perkins currently has an ROCE of 4.7%, compared to its ROCE of 2.3% 3 years ago. This makes us think the business might be improving. The image below shows how Travis Perkins’s ROCE compares to its industry, and you can click it to see more detail on its 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. 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 Travis Perkins.
Do Travis Perkins’s Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
Travis Perkins has current liabilities of UK£1.9b and total assets of UK£6.4b. Therefore its current liabilities are equivalent to approximately 30% of its total assets. Travis Perkins has a medium level of current liabilities, which would boost its ROCE somewhat.
Our Take On Travis Perkins’s ROCE
With this level of liabilities and a mediocre ROCE, there are potentially better investments out there. You might be able to find a better investment than Travis Perkins. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
Travis Perkins is not the only stock insiders are buying. So take a peek at this free list of growing companies with insider buying.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.
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