Today we'll evaluate Compagnie Générale des Établissements Michelin (EPA:ML) to determine whether it could have potential as an investment idea. 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. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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?
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 Compagnie Générale des Établissements Michelin:
0.11 = €2.7b ÷ (€32b - €8.3b) (Based on the trailing twelve months to June 2019.)
Therefore, Compagnie Générale des Établissements Michelin has an ROCE of 11%.
Does Compagnie Générale des Établissements Michelin Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. We can see Compagnie Générale des Établissements Michelin's ROCE is around the 12% average reported by the Auto Components industry. Independently of how Compagnie Générale des Établissements Michelin compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
You can click on the image below to see (in greater detail) how Compagnie Générale des Établissements Michelin's past growth compares to other companies.
When considering this metric, keep in mind that it is backwards looking, and 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Compagnie Générale des Établissements Michelin.
Do Compagnie Générale des Établissements Michelin's Current Liabilities Skew 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Compagnie Générale des Établissements Michelin has total assets of €32b and current liabilities of €8.3b. As a result, its current liabilities are equal to approximately 26% of its total assets. Low current liabilities are not boosting the ROCE too much.
What We Can Learn From Compagnie Générale des Établissements Michelin's ROCE
With that in mind, Compagnie Générale des Établissements Michelin's ROCE appears pretty good. Compagnie Générale des Établissements Michelin 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.
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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.