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Today we’ll look at L’Oréal S.A. (EPA:OR) and reflect on its potential as an investment. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First of all, we’ll work out how to calculate ROCE. 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 measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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’.
So, How Do We Calculate ROCE?
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 L’Oréal:
0.17 = €4.9b ÷ (€38b – €10b) (Based on the trailing twelve months to December 2018.)
Therefore, L’Oréal has an ROCE of 17%.
Is L’Oréal’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that L’Oréal’s ROCE is meaningfully better than the 14% average in the Personal Products industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Separate from L’Oréal’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for L’Oréal.
What Are Current Liabilities, And How Do They Affect L’Oréal’s 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 the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counteract this, we check if a company has high current liabilities, relative to its total assets.
L’Oréal has total assets of €38b and current liabilities of €10b. Therefore its current liabilities are equivalent to approximately 26% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
The Bottom Line On L’Oréal’s ROCE
With that in mind, L’Oréal’s ROCE appears pretty good. There might be better investments than L’Oréal 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.
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 firstname.lastname@example.org. 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.