Today we’ll evaluate Jerónimo Martins, SGPS, S.A. (ELI:JMT) 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 of all, we’ll work out how to calculate ROCE. Then we’ll compare its ROCE to similar companies. And finally, we’ll look at how its current liabilities are impacting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. 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.’
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 Jerónimo Martins SGPS:
0.21 = €588m ÷ (€6.1b – €3.4b) (Based on the trailing twelve months to December 2018.)
Therefore, Jerónimo Martins SGPS has an ROCE of 21%.
Does Jerónimo Martins SGPS Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Jerónimo Martins SGPS’s ROCE appears to be substantially greater than the 9.9% average in the Consumer Retailing 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. Setting aside the comparison to its industry for a moment, Jerónimo Martins SGPS’s ROCE in absolute terms currently looks quite high.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Jerónimo Martins SGPS.
How Jerónimo Martins SGPS’s Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Jerónimo Martins SGPS has total assets of €6.1b and current liabilities of €3.4b. Therefore its current liabilities are equivalent to approximately 55% of its total assets. While a high level of current liabilities boosts its ROCE, Jerónimo Martins SGPS’s returns are still very good.
The Bottom Line On Jerónimo Martins SGPS’s ROCE
In my book, this business could be worthy of further research. You might be able to find a better buy than Jerónimo Martins SGPS. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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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If you spot an error that warrants correction, please contact the editor at email@example.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.