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Today we are going to look at Aristocrat Leisure Limited (ASX:ALL) to see whether it might be an attractive investment prospect. 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. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect 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. 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?
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 Aristocrat Leisure:
0.19 = AU$916m ÷ (AU$5.8b - AU$1.0b) (Based on the trailing twelve months to September 2018.)
So, Aristocrat Leisure has an ROCE of 19%.
Is Aristocrat Leisure's ROCE Good?
One way to assess ROCE is to compare similar companies. In our analysis, Aristocrat Leisure's ROCE is meaningfully higher than the 9.9% average in the Hospitality industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from Aristocrat Leisure's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
In our analysis, Aristocrat Leisure's ROCE appears to be 19%, compared to 3 years ago, when its ROCE was 12%. 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 misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the 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 Aristocrat Leisure.
How Aristocrat Leisure's Current Liabilities Impact Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Aristocrat Leisure has total liabilities of AU$1.0b and total assets of AU$5.8b. Therefore its current liabilities are equivalent to approximately 17% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
Our Take On Aristocrat Leisure's ROCE
This is good to see, and with a sound ROCE, Aristocrat Leisure could be worth a closer look. There might be better investments than Aristocrat Leisure out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
I will like Aristocrat Leisure 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 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.