Why carsales.com Ltd’s (ASX:CAR) Return On Capital Employed Is Impressive

Today we are going to look at carsales.com Ltd (ASX:CAR) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. 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.'

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 carsales.com:

0.22 = AU$188m ÷ (AU$926m - AU$65m) (Based on the trailing twelve months to December 2018.)

Therefore, carsales.com has an ROCE of 22%.

View our latest analysis for carsales.com

Does carsales.com Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. carsales.com's ROCE appears to be substantially greater than the 12% average in the Interactive Media and Services industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Putting aside its position relative to its industry for now, in absolute terms, carsales.com's ROCE is currently very good.

carsales.com's current ROCE of 22% is lower than 3 years ago, when the company reported a 34% ROCE. Therefore we wonder if the company is facing new headwinds.

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for carsales.com.

What Are Current Liabilities, And How Do They Affect carsales.com's 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

carsales.com has total assets of AU$926m and current liabilities of AU$65m. As a result, its current liabilities are equal to approximately 7.0% of its total assets. Minimal current liabilities are not distorting carsales.com's impressive ROCE.

What We Can Learn From carsales.com's ROCE

This is an attractive combination and suggests the company could have potential. carsales.com shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.

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

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 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. Thank you for reading.