Today we'll look at Seven Group Holdings Limited (ASX:SVW) 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. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.
What is 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. 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. 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 Seven Group Holdings:
0.098 = AU$534m ÷ (AU$6.2b - AU$713m) (Based on the trailing twelve months to December 2018.)
Therefore, Seven Group Holdings has an ROCE of 9.8%.
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Is Seven Group Holdings's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. It appears that Seven Group Holdings's ROCE is fairly close to the Trade Distributors industry average of 9.8%. Setting aside the industry comparison for now, Seven Group Holdings's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.
Seven Group Holdings reported an ROCE of 9.8% -- better than 3 years ago, when the company didn't make a profit. That implies the business has been improving.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Seven Group Holdings.
What Are Current Liabilities, And How Do They Affect Seven Group Holdings's 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.
Seven Group Holdings has total liabilities of AU$713m and total assets of AU$6.2b. As a result, its current liabilities are equal to approximately 12% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
Our Take On Seven Group Holdings's ROCE
If Seven Group Holdings continues to earn an uninspiring ROCE, there may be better places to invest. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
If you are like me, then you will not want to miss this free list of growing companies that insiders are 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 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.