Today we’ll look at Johnson Matthey Plc (LON:JMAT) and reflect on its potential as an investment. 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.
Firstly, we’ll go over how we calculate ROCE. 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. All else being equal, a better business will have a higher ROCE. 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?
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 Johnson Matthey:
0.14 = UK£529m ÷ (UK£5.1b – UK£1.3b) (Based on the trailing twelve months to September 2018.)
Therefore, Johnson Matthey has an ROCE of 14%.
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Is Johnson Matthey’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. We can see Johnson Matthey’s ROCE is around the 13% average reported by the Chemicals industry. Regardless of where Johnson Matthey sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
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. 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 Johnson Matthey.
Do Johnson Matthey’s Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Johnson Matthey has total liabilities of UK£1.3b and total assets of UK£5.1b. Therefore its current liabilities are equivalent to approximately 25% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
The Bottom Line On Johnson Matthey’s ROCE
Overall, Johnson Matthey has a decent ROCE and could be worthy of further research. There might be better investments than Johnson Matthey 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.
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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.