Today we'll look at Meggitt PLC (LON:MGGT) 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. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting 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. Generally speaking a higher ROCE is better. 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 Meggitt:
0.094 = UK£364m ÷ (UK£4.7b - UK£885m) (Based on the trailing twelve months to December 2019.)
So, Meggitt has an ROCE of 9.4%.
See our latest analysis for Meggitt
Does Meggitt Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. We can see Meggitt's ROCE is around the 9.9% average reported by the Aerospace & Defense industry. Separate from Meggitt's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
In our analysis, Meggitt's ROCE appears to be 9.4%, compared to 3 years ago, when its ROCE was 5.8%. This makes us think about whether the company has been reinvesting shrewdly. You can click on the image below to see (in greater detail) how Meggitt's past growth compares to other companies.
When considering this metric, keep in mind that it is backwards looking, and 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. ROCE is, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for Meggitt.
Meggitt's Current Liabilities And Their Impact On Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Meggitt has total assets of UK£4.7b and current liabilities of UK£885m. Therefore its current liabilities are equivalent to approximately 19% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
What We Can Learn From Meggitt's ROCE
Overall, Meggitt has a decent ROCE and could be worthy of further research. Meggitt 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.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
Love or hate this article? Concerned about the content? Get in touch with us directly. Alternatively, email 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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.