Augean plc (LON:AUG) Earns Among The Best Returns In Its Industry
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Today we'll evaluate Augean plc (LON:AUG) 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.
Firstly, 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.
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. 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 Augean:
0.16 = UK£12m ÷ (UK£95m - UK£24m) (Based on the trailing twelve months to December 2018.)
So, Augean has an ROCE of 16%.
See our latest analysis for Augean
Does Augean Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Augean's ROCE appears to be substantially greater than the 11% average in the Commercial Services industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from Augean's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
As we can see, Augean currently has an ROCE of 16% compared to its ROCE 3 years ago, which was 9.9%. This makes us think about whether the company has been reinvesting shrewdly.
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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Augean.
How Augean's Current Liabilities Impact Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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.
Augean has total assets of UK£95m and current liabilities of UK£24m. As a result, its current liabilities are equal to approximately 25% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
What We Can Learn From Augean's ROCE
With that in mind, Augean's ROCE appears pretty good. Augean 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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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.
