Today we'll look at John Wood Group PLC (LON:WG.) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting 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. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. 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'.
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 John Wood Group:
0.043 = US$346m ÷ (US$12b - US$4.0b) (Based on the trailing twelve months to June 2019.)
Therefore, John Wood Group has an ROCE of 4.3%.
Does John Wood Group Have A Good ROCE?
One way to assess ROCE is to compare similar companies. In this analysis, John Wood Group's ROCE appears meaningfully below the 7.3% average reported by the Energy Services industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Separate from how John Wood Group stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.
John Wood Group's current ROCE of 4.3% is lower than its ROCE in the past, which was 8.0%, 3 years ago. So investors might consider if it has had issues recently. The image below shows how John Wood Group's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. Remember that most companies like John Wood Group are cyclical businesses. 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 John Wood Group's ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counter this, investors can check if a company has high current liabilities relative to total assets.
John Wood Group has total assets of US$12b and current liabilities of US$4.0b. Therefore its current liabilities are equivalent to approximately 33% of its total assets. John Wood Group's middling level of current liabilities have the effect of boosting its ROCE a bit.
The Bottom Line On John Wood Group's ROCE
With this level of liabilities and a mediocre ROCE, there are potentially better investments out there. You might be able to find a better investment than John Wood Group. 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).
I will like John Wood 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.
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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.