Today we'll look at Croda International Plc (LON:CRDA) 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 up, we'll look at what ROCE is and how we calculate it. 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 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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.'
How Do You Calculate Return On Capital Employed?
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 Croda International:
0.21 = UK£331m ÷ (UK£2.0b - UK£353m) (Based on the trailing twelve months to June 2019.)
So, Croda International has an ROCE of 21%.
Does Croda International Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Croda International's ROCE appears to be substantially greater than the 12% 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. Regardless of the industry comparison, in absolute terms, Croda International's ROCE currently appears to be excellent.
You can see in the image below how Croda International's ROCE compares to its industry. Click to see more on past growth.
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 Croda International.
What Are Current Liabilities, And How Do They Affect Croda International's ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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.
Croda International has total assets of UK£2.0b and current liabilities of UK£353m. As a result, its current liabilities are equal to approximately 18% of its total assets. This is quite a low level of current liabilities which would not greatly boost the already high ROCE.
The Bottom Line On Croda International's ROCE
This is good to see, and with such a high ROCE, Croda International may be worth a closer look. There might be better investments than Croda International out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
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