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Is Renishaw plc (LON:RSW) Investing Effectively In Its Business?

Simply Wall St

Today we'll evaluate Renishaw plc (LON:RSW) to determine whether it could have potential as an investment idea. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.

Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. 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 Renishaw:

0.14 = UK£98m ÷ (UK£776m - UK£96m) (Based on the trailing twelve months to June 2019.)

So, Renishaw has an ROCE of 14%.

See our latest analysis for Renishaw

Does Renishaw Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. It appears that Renishaw's ROCE is fairly close to the Electronic industry average of 12%. Separate from Renishaw's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

You can click on the image below to see (in greater detail) how Renishaw's past growth compares to other companies.

LSE:RSW Past Revenue and Net Income, August 6th 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. ROCE is, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for Renishaw.

Renishaw's Current Liabilities And Their Impact On Its ROCE

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Renishaw has total assets of UK£776m and current liabilities of UK£96m. As a result, its current liabilities are equal to approximately 12% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.

What We Can Learn From Renishaw's ROCE

With that in mind, Renishaw's ROCE appears pretty good. Renishaw shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.

I will like Renishaw 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.