Today we’ll evaluate McBride plc (LON:MCB) to determine whether it could have potential as an investment idea. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
Firstly, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Then we’ll determine how its current liabilities are affecting 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. All else being equal, a better business will have a higher ROCE. In brief, ROCE 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?
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 McBride:
0.18 = UK£35m ÷ (UK£448m – UK£256m) (Based on the trailing twelve months to June 2018.)
Therefore, McBride has an ROCE of 18%.
Does McBride Have A Good ROCE?
One way to assess ROCE is to compare similar companies. In our analysis, McBride’s ROCE is meaningfully higher than the 13% average in the Household Products industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how McBride compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for McBride.
What Are Current Liabilities, And How Do They Affect McBride’s ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
McBride has total assets of UK£448m and current liabilities of UK£256m. Therefore its current liabilities are equivalent to approximately 57% of its total assets. This is admittedly a high level of current liabilities, improving ROCE substantially.
What We Can Learn From McBride’s ROCE
The ROCE would not look as appealing if the company had fewer current liabilities. You might be able to find a better buy than McBride. 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).
Of course McBride may not be the best stock to buy. So you may wish to see this free collection of other companies that have high ROE and low debt.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.