Why United Carpets Group PLC’s (LON:UCG) Return On Capital Employed Is Impressive

Today we’ll look at United Carpets Group PLC (LON:UCG) and reflect on its potential as an investment. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

First of all, we’ll work out how to calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE measures the amount of pre-tax profits a company can generate from the capital employed 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. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’

How Do You Calculate Return On Capital Employed?

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 United Carpets Group:

0.26 = UK£1.5m ÷ (UK£9.5m – UK£3.7m) (Based on the trailing twelve months to March 2018.)

Therefore, United Carpets Group has an ROCE of 26%.

View our latest analysis for United Carpets Group

Is United Carpets Group’s ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that United Carpets Group’s ROCE is meaningfully better than the 14% average in the Specialty Retail industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of the industry comparison, in absolute terms, United Carpets Group’s ROCE currently appears to be excellent.

AIM:UCG Last Perf December 18th 18
AIM:UCG Last Perf December 18th 18

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 misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the 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 United Carpets Group.

What Are Current Liabilities, And How Do They Affect United Carpets Group’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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

United Carpets Group has total liabilities of UK£3.7m and total assets of UK£9.5m. As a result, its current liabilities are equal to approximately 39% of its total assets. United Carpets Group has a medium level of current liabilities, boosting its ROCE somewhat.

Our Take On United Carpets Group’s ROCE

Still, it has a high ROCE, and may be an interesting prospect for further research. 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 would prefer check out another company — one with potentially superior financials — then do not miss this free list of interesting companies, that have HIGH return on equity 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 editorial-team@simplywallst.com.