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Why We Like The Berkeley Group Holdings plc’s (LON:BKG) 23% Return On Capital Employed

Simply Wall St

Today we'll evaluate The Berkeley Group Holdings plc (LON:BKG) 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.

Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.

What is Return On Capital Employed (ROCE)?

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. 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'.

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 Berkeley Group Holdings:

0.23 = UK£768m ÷ (UK£4.9b - UK£1.6b) (Based on the trailing twelve months to April 2019.)

So, Berkeley Group Holdings has an ROCE of 23%.

View our latest analysis for Berkeley Group Holdings

Does Berkeley Group Holdings Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that Berkeley Group Holdings's ROCE is meaningfully better than the 15% 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, Berkeley Group Holdings's ROCE currently appears to be excellent.

The image below shows how Berkeley Group Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.

LSE:BKG Past Revenue and Net Income, August 5th 2019

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Berkeley Group Holdings's Current Liabilities And Their Impact On Its ROCE

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Berkeley Group Holdings has total liabilities of UK£1.6b and total assets of UK£4.9b. As a result, its current liabilities are equal to approximately 32% of its total assets. Berkeley Group Holdings has a medium level of current liabilities, boosting its ROCE somewhat.

Our Take On Berkeley Group Holdings's ROCE

Despite this, it reports a high ROCE, and may be worth investigating further. Berkeley Group Holdings shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.