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Smiths Group plc (LON:SMIN) Earns A Nice Return On Capital Employed

Today we are going to look at Smiths Group plc (LON:SMIN) to see whether it might be an attractive investment prospect. 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.

First of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.

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

ROCE measures the amount of pre-tax profits a company can generate from the capital employed 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.

How Do You Calculate Return On Capital Employed?

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 Smiths Group:

0.09 = UK£397m ÷ (UK£5.3b - UK£918m) (Based on the trailing twelve months to July 2019.)

Therefore, Smiths Group has an ROCE of 9.0%.

Check out our latest analysis for Smiths Group

Is Smiths Group's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Smiths Group's ROCE is meaningfully better than the 5.9% average in the Industrials industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Separate from how Smiths Group stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.

We can see that, Smiths Group currently has an ROCE of 9.0%, less than the 13% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how Smiths Group's past growth compares to other companies.

LSE:SMIN Past Revenue and Net Income, November 6th 2019
LSE:SMIN Past Revenue and Net Income, November 6th 2019

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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

How Smiths Group's Current Liabilities Impact Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Smiths Group has total liabilities of UK£918m and total assets of UK£5.3b. Therefore its current liabilities are equivalent to approximately 17% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.

The Bottom Line On Smiths Group's ROCE

With that in mind, we're not overly impressed with Smiths Group's ROCE, so it may not be the most appealing prospect. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

Smiths Group is not the only stock that insiders are buying. For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.

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