Today we are going to look at Reliance Worldwide Corporation Limited (ASX:RWC) to see whether it might be an attractive investment prospect. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
Firstly, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’
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 Reliance Worldwide:
0.063 = AU$126m ÷ (AU$2.2b – AU$181m) (Based on the trailing twelve months to June 2018.)
Therefore, Reliance Worldwide has an ROCE of 6.3%.
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Is Reliance Worldwide’s ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, Reliance Worldwide’s ROCE appears to be significantly below the 12% average in the Building industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Setting aside the industry comparison for now, Reliance Worldwide’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.
Reliance Worldwide’s current ROCE of 6.3% is lower than its ROCE in the past, which was 20%, 3 years ago. Therefore we wonder if the company is facing new headwinds.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for Reliance Worldwide.
Do Reliance Worldwide’s Current Liabilities Skew Its ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Reliance Worldwide has total liabilities of AU$181m and total assets of AU$2.2b. Therefore its current liabilities are equivalent to approximately 8.3% of its total assets. Reliance Worldwide has a low level of current liabilities, which have a minimal impact on its uninspiring ROCE.
What We Can Learn From Reliance Worldwide’s ROCE
Reliance Worldwide looks like an ok business, but on this analysis it is not at the top of our buy list. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.