Today we’ll look at United Carpets Group plc (LON:UCG) 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. Next, we’ll compare it to others in its industry. Last but not least, we’ll look at what impact its current liabilities have on 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. 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’.
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 United Carpets Group:
0.18 = UK£1.0m ÷ (UK£10.0m – UK£4.3m) (Based on the trailing twelve months to September 2018.)
Therefore, United Carpets Group has an ROCE of 18%.
Is United Carpets Group’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. United Carpets Group’s ROCE appears to be substantially greater than the 14% average in the Specialty Retail industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Regardless of where United Carpets Group sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
United Carpets Group’s current ROCE of 18% is lower than 3 years ago, when the company reported a 29% ROCE. This makes us wonder if the business is facing new challenges.
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 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 United Carpets Group.
How United Carpets Group’s Current Liabilities Impact Its 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.
United Carpets Group has total assets of UK£10.0m and current liabilities of UK£4.3m. As a result, its current liabilities are equal to approximately 43% of its total assets. United Carpets Group has a medium level of current liabilities, which would boost the ROCE.
What We Can Learn From United Carpets Group’s ROCE
While its ROCE looks good, it’s worth remembering that the current liabilities are making the business look better. Of course you might be able to find a better stock than United Carpets Group. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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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.