Today we'll look at Victrex plc (LON:VCT) and reflect on its potential as an investment. 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 of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.
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 Victrex:
0.23 = UK£112m ÷ (UK£536m - UK£53m) (Based on the trailing twelve months to September 2019.)
Therefore, Victrex has an ROCE of 23%.
Is Victrex's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Victrex's ROCE is meaningfully higher than the 13% average in the Chemicals 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. Setting aside the comparison to its industry for a moment, Victrex's ROCE in absolute terms currently looks quite high.
You can see in the image below how Victrex's ROCE compares to its industry. Click to see more on past growth.
It is important to remember that ROCE shows past performance, and is 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect Victrex's ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Victrex has total liabilities of UK£53m and total assets of UK£536m. As a result, its current liabilities are equal to approximately 9.9% of its total assets. Minimal current liabilities are not distorting Victrex's impressive ROCE.
The Bottom Line On Victrex's ROCE
This suggests the company would be worth researching in more depth. Victrex 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.
I will like Victrex 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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