Today we’ll look at Young & Co.’s Brewery, P.L.C. (LON:YNGA) 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 up, we’ll look at what ROCE is and how we calculate it. Next, we’ll compare it to others in its industry. Finally, we’ll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’
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 Young’s Brewery:
0.058 = UK£48m ÷ (UK£882m – UK£51m) (Based on the trailing twelve months to April 2019.)
So, Young’s Brewery has an ROCE of 5.8%.
Does Young’s Brewery Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. We can see Young’s Brewery’s ROCE is meaningfully below the Hospitality industry average of 7.9%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Separate from how Young’s Brewery stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for Young’s Brewery.
Young’s Brewery’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.
Young’s Brewery has total assets of UK£882m and current liabilities of UK£51m. As a result, its current liabilities are equal to approximately 5.8% of its total assets. Young’s Brewery reports few current liabilities, which have a negligible impact on its unremarkable ROCE.
The Bottom Line On Young’s Brewery’s ROCE
If performance improves, then Young’s Brewery may be an OK investment, especially at the right valuation. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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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.