Today we'll evaluate Babcock International Group PLC (LON:BAB) to determine whether it could have potential as an investment idea. 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 up, we'll look at what ROCE is and how we calculate it. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
How Do You Calculate Return On Capital Employed?
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 Babcock International Group:
0.065 = UK£356m ÷ (UK£7.1b - UK£1.6b) (Based on the trailing twelve months to September 2019.)
Therefore, Babcock International Group has an ROCE of 6.5%.
Does Babcock International Group Have A Good ROCE?
One way to assess ROCE is to compare similar companies. We can see Babcock International Group's ROCE is meaningfully below the Commercial Services industry average of 10%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Aside from the industry comparison, Babcock International Group's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
You can click on the image below to see (in greater detail) how Babcock International Group's past growth compares to other companies.
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 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 Babcock International Group.
Babcock International Group's Current Liabilities And Their Impact On 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 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Babcock International Group has total assets of UK£7.1b and current liabilities of UK£1.6b. As a result, its current liabilities are equal to approximately 22% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
What We Can Learn From Babcock International Group's ROCE
That said, Babcock International Group's ROCE is mediocre, there may be more attractive investments around. Of course, you might also be able to find a better stock than Babcock International Group. So you may wish to see this free collection of other companies that have grown earnings strongly.
There are plenty of other companies that have insiders buying up shares. You probably do not want to miss this free list of growing companies that insiders are buying.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.
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