U.S. Markets open in 2 hrs 7 mins

Should You Like InterContinental Hotels Group PLC’s (LON:IHG) High Return On Capital Employed?

Simply Wall St

Today we'll evaluate InterContinental Hotels Group PLC (LON:IHG) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. 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.

How Do You Calculate Return On Capital Employed?

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 InterContinental Hotels Group:

0.26 = US$745m ÷ (US$4.1b - US$1.3b) (Based on the trailing twelve months to June 2019.)

So, InterContinental Hotels Group has an ROCE of 26%.

Check out our latest analysis for InterContinental Hotels Group

Does InterContinental Hotels Group Have A Good ROCE?

One way to assess ROCE is to compare similar companies. Using our data, we find that InterContinental Hotels Group's ROCE is meaningfully better than the 7.5% average in the Hospitality industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Putting aside its position relative to its industry for now, in absolute terms, InterContinental Hotels Group's ROCE is currently very good.

InterContinental Hotels Group's current ROCE of 26% is lower than its ROCE in the past, which was 45%, 3 years ago. Therefore we wonder if the company is facing new headwinds. You can see in the image below how InterContinental Hotels Group's ROCE compares to its industry. Click to see more on past growth.

LSE:IHG Past Revenue and Net Income, September 25th 2019

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.

What Are Current Liabilities, And How Do They Affect InterContinental Hotels Group's 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 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.

InterContinental Hotels Group has total liabilities of US$1.3b and total assets of US$4.1b. Therefore its current liabilities are equivalent to approximately 31% of its total assets. A medium level of current liabilities boosts InterContinental Hotels Group's ROCE somewhat.

The Bottom Line On InterContinental Hotels Group's ROCE

Still, it has a high ROCE, and may be an interesting prospect for further research. InterContinental Hotels Group 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.

I will like InterContinental Hotels Group better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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.