Shareholders Should Look Hard At National Express Group PLC’s (LON:NEX) 10%Return On Capital

Today we’ll evaluate National Express Group PLC (LON:NEX) 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 of all, we’ll work out how to calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. And finally, we’ll look at how its current liabilities are impacting its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. 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 National Express Group:

0.10 = UK£243m ÷ (UK£4.1b – UK£1.6b) (Based on the trailing twelve months to June 2019.)

So, National Express Group has an ROCE of 10%.

See our latest analysis for National Express Group

Does National Express Group Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. We can see National Express Group’s ROCE is meaningfully below the Transportation industry average of 14%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how National Express Group compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

You can see in the image below how National Express Group’s ROCE compares to its industry. Click to see more on past growth.

LSE:NEX Past Revenue and Net Income, February 28th 2020
LSE:NEX Past Revenue and Net Income, February 28th 2020

Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately 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, after all, simply a snap shot of a single year. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

What Are Current Liabilities, And How Do They Affect National Express Group’s 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.

National Express Group has current liabilities of UK£1.6b and total assets of UK£4.1b. As a result, its current liabilities are equal to approximately 40% of its total assets. With this level of current liabilities, National Express Group’s ROCE is boosted somewhat.

Our Take On National Express Group’s ROCE

While its ROCE looks good, it’s worth remembering that the current liabilities are making the business look better. There might be better investments than National Express Group 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.

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.

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