Today we'll look at Rexel S.A. (EPA:RXL) and reflect on its potential as an investment. 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 up, we'll look at what ROCE is and how we calculate it. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
What is 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. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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 Rexel:
0.082 = €598m ÷ (€11b - €3.9b) (Based on the trailing twelve months to June 2019.)
Therefore, Rexel has an ROCE of 8.2%.
Is Rexel's ROCE Good?
One way to assess ROCE is to compare similar companies. It appears that Rexel's ROCE is fairly close to the Trade Distributors industry average of 8.2%. Independently of how Rexel compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
You can click on the image below to see (in greater detail) how Rexel's past growth compares to other companies.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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 Rexel.
Do Rexel'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 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.
Rexel has total liabilities of €3.9b and total assets of €11b. As a result, its current liabilities are equal to approximately 35% of its total assets. With this level of current liabilities, Rexel's ROCE is boosted somewhat.
Our Take On Rexel's ROCE
While its ROCE looks good, it's worth remembering that the current liabilities are making the business look better. There might be better investments than Rexel 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 Rexel better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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.
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