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Has Castings P.L.C. (LON:CGS) Been Employing Capital Shrewdly?

Simply Wall St

Today we'll look at Castings P.L.C. (LON:CGS) and reflect on its potential as an investment. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

First, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its 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?

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 Castings:

0.13 = UK£17m ÷ (UK£155m - UK£22m) (Based on the trailing twelve months to September 2019.)

Therefore, Castings has an ROCE of 13%.

Check out our latest analysis for Castings

Is Castings's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, Castings's ROCE appears to be around the 13% average of the Metals and Mining industry. Regardless of where Castings sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

You can click on the image below to see (in greater detail) how Castings's past growth compares to other companies.

LSE:CGS Past Revenue and Net Income, December 31st 2019

It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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. Remember that most companies like Castings are cyclical businesses. Since the future is so important for investors, you should check out our free report on analyst forecasts for Castings.

What Are Current Liabilities, And How Do They Affect Castings's ROCE?

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Castings has total assets of UK£155m and current liabilities of UK£22m. As a result, its current liabilities are equal to approximately 14% of its total assets. Low current liabilities are not boosting the ROCE too much.

What We Can Learn From Castings's ROCE

With that in mind, Castings's ROCE appears pretty good. Castings 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 are like me, then you will 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 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.

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. Thank you for reading.