Today we'll look at Imperial Brands PLC (LON:IMB) and reflect on its potential as an investment. 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, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared 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 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. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.
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 Imperial Brands:
0.13 = UK£2.8b ÷ (UK£34b - UK£12b) (Based on the trailing twelve months to September 2019.)
Therefore, Imperial Brands has an ROCE of 13%.
Does Imperial Brands Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. It appears that Imperial Brands's ROCE is fairly close to the Tobacco industry average of 13%. Independently of how Imperial Brands compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
The image below shows how Imperial Brands's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the 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 Imperial Brands's Current Liabilities Skew Its 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 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Imperial Brands has total assets of UK£34b and current liabilities of UK£12b. Therefore its current liabilities are equivalent to approximately 37% of its total assets. Imperial Brands has a medium level of current liabilities, which would boost the ROCE.
Our Take On Imperial Brands's ROCE
While its ROCE looks good, it's worth remembering that the current liabilities are making the business look better. Imperial Brands 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.
Imperial Brands 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.
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