Why We Like Clarkson PLC’s (LON:CKN) 9.6% Return On Capital Employed

Today we’ll evaluate Clarkson PLC (LON:CKN) 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 of all, we’ll work out how to calculate ROCE. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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’.

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 Clarkson:

0.096 = UK£44m ÷ (UK£600m – UK£144m) (Based on the trailing twelve months to December 2018.)

Therefore, Clarkson has an ROCE of 9.6%.

View our latest analysis for Clarkson

Does Clarkson Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Clarkson’s ROCE is meaningfully higher than the 3.9% average in the Shipping industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how Clarkson compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

LSE:CKN Past Revenue and Net Income, April 14th 2019
LSE:CKN Past Revenue and Net Income, April 14th 2019

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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

What Are Current Liabilities, And How Do They Affect Clarkson’s 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 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.

Clarkson has total liabilities of UK£144m and total assets of UK£600m. Therefore its current liabilities are equivalent to approximately 24% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.

Our Take On Clarkson’s ROCE

With that in mind, Clarkson’s ROCE appears pretty good. There might be better investments than Clarkson 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.

I will like Clarkson better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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.