Today we are going to look at Taylor Wimpey plc (LON:TW.) to see whether it might be an attractive investment prospect. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First of all, we’ll work out how to calculate ROCE. 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.
Return On Capital Employed (ROCE): What is it?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. 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.’
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 Taylor Wimpey:
0.23 = UK£828m ÷ (UK£5.3b – UK£1.6b) (Based on the trailing twelve months to July 2018.)
So, Taylor Wimpey has an ROCE of 23%.
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Is Taylor Wimpey’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Taylor Wimpey’s ROCE is meaningfully better than the 17% average in the Consumer Durables 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. Regardless of the industry comparison, in absolute terms, Taylor Wimpey’s ROCE currently appears to be excellent.
In our analysis, Taylor Wimpey’s ROCE appears to be 23%, compared to 3 years ago, when its ROCE was 17%. This makes us think about whether the company has been reinvesting shrewdly.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for Taylor Wimpey.
What Are Current Liabilities, And How Do They Affect Taylor Wimpey’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. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Taylor Wimpey has total liabilities of UK£1.6b and total assets of UK£5.3b. As a result, its current liabilities are equal to approximately 31% of its total assets. A medium level of current liabilities boosts Taylor Wimpey’s ROCE somewhat.
What We Can Learn From Taylor Wimpey’s ROCE
Despite this, it reports a high ROCE, and may be worth investigating further. Of course you might be able to find a better stock than Taylor Wimpey. So you may wish to see this free collection of other companies that have grown earnings strongly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.