Today we'll look at CIMIC Group Limited (ASX:CIM) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed 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 CIMIC Group:
0.36 = AU$1.1b ÷ (AU$9.2b - AU$6.1b) (Based on the trailing twelve months to December 2018.)
So, CIMIC Group has an ROCE of 36%.
Does CIMIC Group Have A Good ROCE?
One way to assess ROCE is to compare similar companies. CIMIC Group's ROCE appears to be substantially greater than the 20% average in the Construction 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 the industry comparison, in absolute terms, CIMIC Group's ROCE currently appears to be excellent.
As we can see, CIMIC Group currently has an ROCE of 36% compared to its ROCE 3 years ago, which was 17%. This makes us wonder if the company is improving.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for CIMIC Group.
How CIMIC Group'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. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
CIMIC Group has total assets of AU$9.2b and current liabilities of AU$6.1b. Therefore its current liabilities are equivalent to approximately 67% of its total assets. CIMIC Group boasts an attractive ROCE, even after considering the boost from high current liabilities.
What We Can Learn From CIMIC Group's ROCE
In my book, this business could be worthy of further research. You might be able to find a better buy than CIMIC Group. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
I will like CIMIC Group better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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If you spot an error that warrants correction, please contact the editor at email@example.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.