Do You Know About Royal Mail plc’s (LON:RMG) ROCE?

Today we are going to look at Royal Mail plc (LON:RMG) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into 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.

What is 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. 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'.

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 Royal Mail:

0.10 = UK£545m ÷ (UK£7.4b - UK£2.0b) (Based on the trailing twelve months to March 2019.)

So, Royal Mail has an ROCE of 10%.

View our latest analysis for Royal Mail

Is Royal Mail's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. We can see Royal Mail's ROCE is around the 9.8% average reported by the Logistics industry. Independently of how Royal Mail compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

You can see in the image below how Royal Mail's ROCE compares to its industry.

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, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for Royal Mail.

How Royal Mail'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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Royal Mail has total assets of UK£7.4b and current liabilities of UK£2.0b. As a result, its current liabilities are equal to approximately 27% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.

The Bottom Line On Royal Mail's ROCE

With that in mind, Royal Mail's ROCE appears pretty good. Royal Mail shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.