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Has Compagnie Financière Richemont SA (VTX:CFR) Been Employing Capital Shrewdly?

Simply Wall St

Today we'll look at Compagnie Financière Richemont SA (VTX:CFR) 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. Last but not least, we'll look at what impact its current liabilities have on its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. 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.

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 Financière Richemont:

0.089 = €1.9b ÷ (€28b - €6.3b) (Based on the trailing twelve months to March 2019.)

Therefore, Compagnie Financière Richemont has an ROCE of 8.9%.

Check out our latest analysis for Compagnie Financière Richemont

Does Compagnie Financière Richemont Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Compagnie Financière Richemont's ROCE appears to be around the 8.9% average of the Luxury industry. Separate from how Compagnie Financière Richemont stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.

Compagnie Financière Richemont's current ROCE of 8.9% is lower than 3 years ago, when the company reported a 13% ROCE. This makes us wonder if the business is facing new challenges. You can click on the image below to see (in greater detail) how Compagnie Financière Richemont's past growth compares to other companies.

SWX:CFR Past Revenue and Net Income, October 19th 2019

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. ROCE is, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for Compagnie Financière Richemont.

How Compagnie Financière Richemont'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. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Compagnie Financière Richemont has total assets of €28b and current liabilities of €6.3b. As a result, its current liabilities are equal to approximately 22% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.

Our Take On Compagnie Financière Richemont's ROCE

If Compagnie Financière Richemont continues to earn an uninspiring ROCE, there may be better places to invest. You might be able to find a better investment than Compagnie Financière Richemont. 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).

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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 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. Thank you for reading.