Today we'll evaluate West Pharmaceutical Services, Inc. (NYSE:WST) to determine whether it could have potential as an investment idea. 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, we'll go over how we 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 amount of pre-tax profits a company can generate from the 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.
How Do You Calculate Return On Capital Employed?
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 West Pharmaceutical Services:
0.15 = US$275m ÷ (US$2.1b - US$313m) (Based on the trailing twelve months to June 2019.)
Therefore, West Pharmaceutical Services has an ROCE of 15%.
Is West Pharmaceutical Services's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that West Pharmaceutical Services's ROCE is meaningfully better than the 10.0% average in the Medical Equipment industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where West Pharmaceutical Services sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
In our analysis, West Pharmaceutical Services's ROCE appears to be 15%, compared to 3 years ago, when its ROCE was 11%. This makes us think the business might be improving. You can see in the image below how West Pharmaceutical Services's ROCE compares to its industry. Click to see more on past growth.
It is important to remember that ROCE shows past performance, and is 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for West Pharmaceutical Services.
How West Pharmaceutical Services's Current Liabilities Impact 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 counter this, investors can check if a company has high current liabilities relative to total assets.
West Pharmaceutical Services has total liabilities of US$313m and total assets of US$2.1b. Therefore its current liabilities are equivalent to approximately 15% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
Our Take On West Pharmaceutical Services's ROCE
This is good to see, and with a sound ROCE, West Pharmaceutical Services could be worth a closer look. West Pharmaceutical Services looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
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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 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. Thank you for reading.