Today we’ll evaluate Cosan Limited (NYSE:CZZ) to determine whether it could have potential as an investment idea. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First up, we’ll look at what ROCE is and how we calculate it. Second, we’ll look at its ROCE compared to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
Understanding 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. 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?
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 Cosan:
0.074 = R$4.1b ÷ (R$64b – R$8.5b) (Based on the trailing twelve months to September 2019.)
Therefore, Cosan has an ROCE of 7.4%.
Is Cosan’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. It appears that Cosan’s ROCE is fairly close to the Oil and Gas industry average of 9.0%. Setting aside the industry comparison for now, Cosan’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.
Our data shows that Cosan currently has an ROCE of 7.4%, compared to its ROCE of 5.8% 3 years ago. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how Cosan’s past growth compares to other companies.
It is important to remember that ROCE shows past performance, and is 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Remember that most companies like Cosan are cyclical businesses. Since the future is so important for investors, you should check out our free report on analyst forecasts for Cosan.
Cosan’s Current Liabilities And Their Impact On Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Cosan has total liabilities of R$8.5b and total assets of R$64b. Therefore its current liabilities are equivalent to approximately 13% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
Our Take On Cosan’s ROCE
With that in mind, we’re not overly impressed with Cosan’s ROCE, so it may not be the most appealing prospect. You might be able to find a better investment than Cosan. 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).
If you are like me, then you will not want to miss this free list of growing companies that insiders are 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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