Don’t Buy WSP Global Inc. (TSE:WSP) Until You Understand Its ROCE

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Today we’ll look at WSP Global Inc. (TSE:WSP) and reflect on its potential as an investment. 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 up, we’ll look at what ROCE is and how we calculate it. Second, we’ll look at its ROCE compared to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.

Understanding Return On Capital Employed (ROCE)

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 WSP Global:

0.10 = CA$369m ÷ (CA$6.6b – CA$2.3b) (Based on the trailing twelve months to September 2018.)

Therefore, WSP Global has an ROCE of 10%.

Check out our latest analysis for WSP Global

Is WSP Global’s ROCE Good?

One way to assess ROCE is to compare similar companies. We can see WSP Global’s ROCE is around the 10% average reported by the Construction industry. Independently of how WSP Global compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

Our data shows that WSP Global currently has an ROCE of 10%, compared to its ROCE of 6.8% 3 years ago. This makes us think the business might be improving.

TSX:WSP Last Perf February 12th 19
TSX:WSP Last Perf February 12th 19

It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. 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 WSP Global.

What Are Current Liabilities, And How Do They Affect WSP Global’s ROCE?

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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.

WSP Global has total liabilities of CA$2.3b and total assets of CA$6.6b. As a result, its current liabilities are equal to approximately 35% of its total assets. WSP Global has a medium level of current liabilities, which would boost the ROCE.

Our Take On WSP Global’s ROCE

While its ROCE looks good, it’s worth remembering that the current liabilities are making the business look better. But note: WSP Global may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

I will like WSP Global better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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 editorial-team@simplywallst.com.