Today we’ll evaluate Driver Group plc (LON:DRV) to determine whether it could have potential as an investment idea. 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. Then we’ll compare its ROCE to similar companies. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. 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 Driver Group:
0.11 = UK£2.1m ÷ (UK£30m – UK£12m) (Based on the trailing twelve months to March 2019.)
Therefore, Driver Group has an ROCE of 11%.
Does Driver Group Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, Driver Group’s ROCE appears to be significantly below the 18% average in the Construction industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Regardless of where Driver Group sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Driver Group delivered an ROCE of 11%, which is better than 3 years ago, as was making losses back then. That implies the business has been improving. The image below shows how Driver Group’s ROCE compares to its industry.
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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Driver Group.
What Are Current Liabilities, And How Do They Affect Driver Group’s ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that 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.
Driver Group has total assets of UK£30m and current liabilities of UK£12m. Therefore its current liabilities are equivalent to approximately 39% of its total assets. With this level of current liabilities, Driver Group’s ROCE is boosted somewhat.
What We Can Learn From Driver Group’s ROCE
Driver Group’s ROCE does look good, but the level of current liabilities also contribute to that. There might be better investments than Driver Group 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.
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 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.