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Are HomeServe plc’s (LON:HSV) High Returns Really That Great?

Simply Wall St

Today we'll evaluate HomeServe plc (LON:HSV) to determine whether it could have potential as an investment idea. 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. 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 metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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 HomeServe:

0.15 = UK£150m ÷ (UK£1.4b - UK£434m) (Based on the trailing twelve months to March 2019.)

So, HomeServe has an ROCE of 15%.

Check out our latest analysis for HomeServe

Does HomeServe Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that HomeServe's ROCE is meaningfully better than the 10% average in the Commercial Services industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how HomeServe compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

You can see in the image below how HomeServe's ROCE compares to its industry. Click to see more on past growth.

LSE:HSV Past Revenue and Net Income, October 11th 2019
LSE:HSV Past Revenue and Net Income, October 11th 2019

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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Do HomeServe's Current Liabilities Skew Its ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

HomeServe has total liabilities of UK£434m and total assets of UK£1.4b. Therefore its current liabilities are equivalent to approximately 30% of its total assets. HomeServe has a middling amount of current liabilities, increasing its ROCE somewhat.

The Bottom Line On HomeServe's ROCE

HomeServe's ROCE does look good, but the level of current liabilities also contribute to that. HomeServe 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.

HomeServe is not the only stock that insiders are buying. 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 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.