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Today we are going to look at AVEVA Group plc (LON:AVV) to see whether it might be an attractive investment prospect. 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, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. 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 AVEVA Group:
0.035 = UK£74m ÷ (UK£2.3b – UK£301m) (Based on the trailing twelve months to September 2018.)
Therefore, AVEVA Group has an ROCE of 3.5%.
Is AVEVA Group’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. We can see AVEVA Group’s ROCE is meaningfully below the Software industry average of 12%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Putting aside AVEVA Group’s performance relative to its industry, its ROCE in absolute terms is poor – considering the risk of owning stocks compared to government bonds. There are potentially more appealing investments elsewhere.
AVEVA Group’s current ROCE of 3.5% is lower than 3 years ago, when the company reported a 18% ROCE. So investors might consider if it has had issues recently.
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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for AVEVA Group.
Do AVEVA Group’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 counter this, investors can check if a company has high current liabilities relative to total assets.
AVEVA Group has total liabilities of UK£301m and total assets of UK£2.3b. Therefore its current liabilities are equivalent to approximately 13% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.
What We Can Learn From AVEVA Group’s ROCE
While that is good to see, AVEVA Group has a low ROCE and does not look attractive in this analysis. Of course you might be able to find a better stock than AVEVA Group. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like AVEVA Group better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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.