Today we are going to look at Reliance Worldwide Corporation Limited (ASX:RWC) 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. Next, we’ll compare it to others in its industry. 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. All else being equal, a better business will have a higher ROCE. 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 Reliance Worldwide:
0.084 = AU$158m ÷ (AU$2.0b – AU$150m) (Based on the trailing twelve months to December 2018.)
Therefore, Reliance Worldwide has an ROCE of 8.4%.
Is Reliance Worldwide’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In this analysis, Reliance Worldwide’s ROCE appears meaningfully below the 11% average reported by the Building industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Aside from the industry comparison, Reliance Worldwide’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.
Reliance Worldwide’s current ROCE of 8.4% is lower than 3 years ago, when the company reported a 22% ROCE. Therefore we wonder if the company is facing new headwinds.
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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Reliance Worldwide.
How Reliance Worldwide’s Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Reliance Worldwide has total assets of AU$2.0b and current liabilities of AU$150m. As a result, its current liabilities are equal to approximately 7.4% of its total assets. With low levels of current liabilities, at least Reliance Worldwide’s mediocre ROCE is not unduly boosted.
What We Can Learn From Reliance Worldwide’s ROCE
Based on this information, Reliance Worldwide appears to be a mediocre business. You might be able to find a better investment than Reliance Worldwide. 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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at email@example.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. Thank you for reading.