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Today we'll evaluate Compagnie des Eaux de Royan (EPA:MLEDR) to determine whether it could have potential as an investment idea. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First up, we'll look at what ROCE is and how we calculate it. 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. In brief, it is a useful tool, but it is not without drawbacks. 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?
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 Compagnie des Eaux de Royan:
0.18 = €2.8m ÷ (€38m - €22m) (Based on the trailing twelve months to December 2017.)
Therefore, Compagnie des Eaux de Royan has an ROCE of 18%.
Is Compagnie des Eaux de Royan's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Compagnie des Eaux de Royan's ROCE is meaningfully higher than the 5.8% average in the Water Utilities industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where Compagnie des Eaux de Royan sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. You can check if Compagnie des Eaux de Royan has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Compagnie des Eaux de Royan's 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Compagnie des Eaux de Royan has total liabilities of €22m and total assets of €38m. As a result, its current liabilities are equal to approximately 58% of its total assets. Compagnie des Eaux de Royan has a relatively high level of current liabilities, boosting its ROCE meaningfully.
What We Can Learn From Compagnie des Eaux de Royan's ROCE
While its ROCE looks decent, it wouldn't look so good if it reduced current liabilities. Compagnie des Eaux de Royan 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.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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 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. Thank you for reading.