Today we are going to look at Penske Automotive Group, Inc. (NYSE:PAG) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into 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. Last but not least, we'll look at what impact its current liabilities have on 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. 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. 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?
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 Penske Automotive Group:
0.11 = US$665m ÷ (US$11b - US$5.0b) (Based on the trailing twelve months to December 2018.)
So, Penske Automotive Group has an ROCE of 11%.
Does Penske Automotive Group Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. We can see Penske Automotive Group's ROCE is around the 13% average reported by the Specialty Retail industry. Separate from Penske Automotive Group's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Penske Automotive Group's current ROCE of 11% is lower than its ROCE in the past, which was 15%, 3 years ago. Therefore we wonder if the company is facing new headwinds.
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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Penske Automotive Group.
Do Penske Automotive Group'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 counter this, investors can check if a company has high current liabilities relative to total assets.
Penske Automotive Group has total assets of US$11b and current liabilities of US$5.0b. Therefore its current liabilities are equivalent to approximately 46% of its total assets. Penske Automotive Group has a medium level of current liabilities, which would boost the ROCE.
Our Take On Penske Automotive Group's ROCE
Penske Automotive Group's ROCE does look good, but the level of current liabilities also contribute to that. Of course you might be able to find a better stock than Penske Automotive Group. So you may wish to see this free collection of other companies that have grown earnings strongly.
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 firstname.lastname@example.org. 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.