Why You Should Care About The Weir Group PLC’s (LON:WEIR) Low Return On Capital

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Today we’ll evaluate The Weir Group PLC (LON:WEIR) to determine whether it could have potential as an investment idea. 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 up, we’ll look at what ROCE is and how we calculate it. Second, we’ll look at its ROCE compared to similar companies. And finally, we’ll look at how its current liabilities are impacting 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. In brief, it is a useful tool, but it is not without drawbacks. 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?

Analysts use this formula to calculate return on capital employed:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)

Or for Weir Group:

0.086 = UK£275m ÷ (UK£4.7b – UK£1.5b) (Based on the trailing twelve months to December 2018.)

Therefore, Weir Group has an ROCE of 8.6%.

See our latest analysis for Weir Group

Is Weir Group’s ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. We can see Weir Group’s ROCE is meaningfully below the Machinery industry average of 13%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Setting aside the industry comparison for now, Weir Group’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.

LSE:WEIR Past Revenue and Net Income, May 6th 2019
LSE:WEIR Past Revenue and Net Income, May 6th 2019

It is important to remember that ROCE shows past performance, and is 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Weir Group.

Weir Group’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. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Weir Group has total assets of UK£4.7b and current liabilities of UK£1.5b. As a result, its current liabilities are equal to approximately 33% of its total assets. Weir Group has a medium level of current liabilities, which would boost its ROCE somewhat.

What We Can Learn From Weir Group’s ROCE

With this level of liabilities and a mediocre ROCE, there are potentially better investments out there. You might be able to find a better investment than Weir Group. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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