Today we'll evaluate Midwich Group Plc (LON:MIDW) 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.
First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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?
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 Midwich Group:
0.21 = UK£25m ÷ (UK£281m - UK£163m) (Based on the trailing twelve months to December 2019.)
Therefore, Midwich Group has an ROCE of 21%.
Check out our latest analysis for Midwich Group
Does Midwich Group Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Midwich Group's ROCE appears to be substantially greater than the 9.3% average in the Electronic 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, Midwich Group's ROCE currently appears to be excellent.
We can see that, Midwich Group currently has an ROCE of 21%, less than the 29% it reported 3 years ago. This makes us wonder if the business is facing new challenges. The image below shows how Midwich Group's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
How Midwich Group's Current Liabilities Impact Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. 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.
Midwich Group has current liabilities of UK£163m and total assets of UK£281m. As a result, its current liabilities are equal to approximately 58% of its total assets. Midwich Group's high level of current liabilities boost the ROCE - but its ROCE is still impressive.
What We Can Learn From Midwich Group's ROCE
So to us, the company is potentially worth investigating further. Midwich Group looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.