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Shareholders Should Look Hard At EssilorLuxottica Société anonyme’s (EPA:EL) 4.4% Return On Capital

Simply Wall St

Today we'll evaluate EssilorLuxottica Société anonyme (EPA:EL) to determine whether it could have potential as an investment idea. 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. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its 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 EssilorLuxottica Société anonyme:

0.044 = €1.8b ÷ (€48b - €6.8b) (Based on the trailing twelve months to June 2019.)

So, EssilorLuxottica Société anonyme has an ROCE of 4.4%.

Check out our latest analysis for EssilorLuxottica Société anonyme

Does EssilorLuxottica Société anonyme Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, EssilorLuxottica Société anonyme's ROCE appears meaningfully below the 7.5% average reported by the Luxury industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Aside from the industry comparison, EssilorLuxottica Société anonyme'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.

EssilorLuxottica Société anonyme's current ROCE of 4.4% is lower than its ROCE in the past, which was 14%, 3 years ago. This makes us wonder if the business is facing new challenges. The image below shows how EssilorLuxottica Société anonyme's ROCE compares to its industry, and you can click it to see more detail on its past growth.

ENXTPA:EL Past Revenue and Net Income, September 17th 2019

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for EssilorLuxottica Société anonyme.

How EssilorLuxottica Société anonyme's Current Liabilities Impact 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. 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.

EssilorLuxottica Société anonyme has total assets of €48b and current liabilities of €6.8b. As a result, its current liabilities are equal to approximately 14% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.

The Bottom Line On EssilorLuxottica Société anonyme's ROCE

That said, EssilorLuxottica Société anonyme's ROCE is mediocre, there may be more attractive investments around. 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).

I will like EssilorLuxottica Société anonyme 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.