Today we'll look at Foley Family Wines Limited (NZSE:FWL) 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 of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Understanding 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. Overall, it is a valuable metric that has its flaws. 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 Foley Family Wines:
0.042 = NZ$7.2m ÷ (NZ$193m - NZ$21m) (Based on the trailing twelve months to June 2019.)
Therefore, Foley Family Wines has an ROCE of 4.2%.
Is Foley Family Wines's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In this analysis, Foley Family Wines's ROCE appears meaningfully below the 9.8% average reported by the Beverage industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how Foley Family Wines compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.4% available in government bonds. It is likely that there are more attractive prospects out there.
Foley Family Wines's current ROCE of 4.2% is lower than its ROCE in the past, which was 7.4%, 3 years ago. Therefore we wonder if the company is facing new headwinds. You can see in the image below how Foley Family Wines's ROCE compares to its industry. Click to see more on past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. 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 Foley Family Wines 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 Foley Family Wines'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 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.
Foley Family Wines has total assets of NZ$193m and current liabilities of NZ$21m. As a result, its current liabilities are equal to approximately 11% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.
Our Take On Foley Family Wines's ROCE
While that is good to see, Foley Family Wines has a low ROCE and does not look attractive in this analysis. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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.