Today we are going to look at Aristocrat Leisure Limited (ASX:ALL) to see whether it might be an attractive investment prospect. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared 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. Overall, it is a valuable metric that has its flaws. 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 Aristocrat Leisure:
0.15 = AU$1.1b ÷ (AU$8.2b - AU$1.1b) (Based on the trailing twelve months to March 2020.)
So, Aristocrat Leisure has an ROCE of 15%.
Is Aristocrat Leisure's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Aristocrat Leisure's ROCE is meaningfully better than the 9.2% average in the Hospitality industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Regardless of where Aristocrat Leisure sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Aristocrat Leisure's current ROCE of 15% is lower than 3 years ago, when the company reported a 28% ROCE. Therefore we wonder if the company is facing new headwinds. You can see in the image below how Aristocrat Leisure's ROCE compares to its industry. Click to see more on past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during 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 Aristocrat Leisure.
What Are Current Liabilities, And How Do They Affect Aristocrat Leisure's ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Aristocrat Leisure has total assets of AU$8.2b and current liabilities of AU$1.1b. Therefore its current liabilities are equivalent to approximately 13% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
What We Can Learn From Aristocrat Leisure's ROCE
This is good to see, and with a sound ROCE, Aristocrat Leisure could be worth a closer look. Aristocrat Leisure 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.
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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.