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Are Pernod Ricard SA’s (EPA:RI) High Returns Really That Great?

Simply Wall St

Today we'll evaluate Pernod Ricard SA (EPA:RI) to determine whether it could have potential as an investment idea. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.

Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect 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. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'

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 Pernod Ricard:

0.092 = €2.4b ÷ (€31b - €4.1b) (Based on the trailing twelve months to December 2018.)

So, Pernod Ricard has an ROCE of 9.2%.

View our latest analysis for Pernod Ricard

Does Pernod Ricard Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Pernod Ricard's ROCE is meaningfully higher than the 4.4% average in the Beverage industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Pernod Ricard compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

You can see in the image below how Pernod Ricard's ROCE compares to its industry. Click to see more on past growth.

ENXTPA:RI Past Revenue and Net Income, August 19th 2019

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Pernod Ricard.

Do Pernod Ricard's Current Liabilities Skew Its ROCE?

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Pernod Ricard has total liabilities of €4.1b and total assets of €31b. Therefore its current liabilities are equivalent to approximately 13% of its total assets. Low current liabilities are not boosting the ROCE too much.

What We Can Learn From Pernod Ricard's ROCE

Overall, Pernod Ricard has a decent ROCE and could be worthy of further research. There might be better investments than Pernod Ricard out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.

I will like Pernod Ricard 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.