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ROCE

Analysing companies' finances and value from their financial statements using ratios and formulae
AsleepInYorkshire
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ROCE

#232235

Postby AsleepInYorkshire » June 26th, 2019, 9:58 pm

I have a vague idea what ROCE is. Return on capital employed.

I have always understood that high ROCE is good for a company. So when I look at financial information I am always keen to see a robust ROCE. That said I don't have a drop dead number.

Recently I started looking at a small FTSE 250 company with a ROCE of 7-9%. Should I view this in isolation as a bad omen or is it part of the bigger picture? Could it be (and the company seems to have plenty of cash) that the ROCE is low due simply to an abundance of cash?

AiY

Alaric
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Re: ROCE

#232238

Postby Alaric » June 26th, 2019, 10:14 pm

AsleepInYorkshire wrote:Could it be (and the company seems to have plenty of cash) that the ROCE is low due simply to an abundance of cash?



That is plausible. If it holds "safe" bank deposits or equivalents in Government securities, it's going to be earning 1% to 2% on a good day.

If the management cannot find anything useful to do with the cash and there's no solvency reason for needing to hold it, returning it to shareholders as a reduction of capital or special dividend is more often than not what eventually happens.

TheMotorcycleBoy
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Re: ROCE

#232261

Postby TheMotorcycleBoy » June 27th, 2019, 6:26 am

AsleepInYorkshire wrote:I have a vague idea what ROCE is. Return on capital employed.

I have always understood that high ROCE is good for a company. So when I look at financial information I am always keen to see a robust ROCE. That said I don't have a drop dead number.

Did you calculate it yourself or just use the number that the firm themselves give in their latest AR? Bear in mind that most firms will over egg their ROCE calcs.

I personally use (operating profit) / (capital employed). For capital employed I use Total Assets - Current Liabilities + Shortterm borrowings.

Recently I started looking at a small FTSE 250 company with a ROCE of 7-9%. Should I view this in isolation as a bad omen or is it part of the bigger picture?

It's part of the whole picture, albeit one of the larger parts. Ideally I try to go for at least 12-15% for several years of trading. The bigger the better!

Could it be (and the company seems to have plenty of cash) that the ROCE is low due simply to an abundance of cash?

A ha! That puts a slightly different spin on things. Then consider calculating the firms ROIC (return on invested capital). This is almost the same as the ROCE calculation except that the denominator is "Invested capital" = "Capital employed" - cash and equivalents - short term investments. Notice how this ratio removes the negative effect of all that cash that is not being utilised. Then I'd probably want to see ROIC a fair bit higher than ROCE.

However you need to ask yourself, why have they got this much cash? For example is it cos they have limited expansion opportunities, or is it because they actually need a lot of cash to keep buying raw materials which (perhaps) perish quickly? (but presumably they wouldn't need the cash cos if they are good they should have a decent credit arrangement with suppliers etc.)

A big consideration for you is "how much bigger is the ROCE compared to the company's cost of capital?". Because it is the difference in these figures that the leaves the company with room to pay it's owners back, or reinvest (without having to use debt).

Finally remember that if the company rents a lot of premises (typically for retailers) then you should do a separate ROCE calculation using Capital Employed adjusted for lease/costs. IIRC in the case of WHSmith this more than halves their ROCE figure.

Hope this helps
Matt

monabri
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Re: ROCE

#232294

Postby monabri » June 27th, 2019, 10:09 am

Is this a typical annual value for ROCE for that company ? It would need to be investigated further...maybe it's an improving metric or conversely a decreasing value, if so, why?

ROCE might be "dragged down" by one part of a business in terminal decline so an easy fix (forgetting all other considerations) might be to flog off that part of the business...hence the overall ROCE improves.

Has something changed which might be reflected in the "asset turnover " .. ( ROCE = Return on Sales x Asset Turnover)

( see link below)

The asset turnover is how fast one can "make a sale, free up the cash, do it again, and again, Mr Tesco "...bringing in as much revenue as possible for the capital in the business within the reporting period. The ROCE might be affected by their ability to no longer pile high, sell cheap (things not necessarily controlled by the business)

But if the business was something like BAE, then they are at the other end of the spectrum so their ROCE might be adversely affected (as an example) by technical delays meaning sales of "big ticket items" are delayed. Sales might then be achieved in the next year perhaps inflating the ROCE for that year " artificially ". Hence the need to look at trend.

https://www.accaglobal.com/uk/en/studen ... lysis.html


In addition, how does the ROCE compare with similar companies? Better or worse?
( use Simplywallstreet for comparison info..free 10 uses per month).

The ROCE figure quoted isn't exciting at that level but if it is an explicable one off and likely to return to a higher value or grow, then maybe.


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